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AN  INTRODUCTION 
TO 

ELEMENTARY  ACCOUNTING 


BY 

A.  C.  Littleton 


AN  INTRODUCTION 
TO 

ELEMENTARY  ACCOUNTING 


WITH  A PROGRAM  OF  STUDY  AND 
PRACTICE  ASSIGNMENTS 


BY 


A.  C.  Littleton,  A.  M. 

ASSOCIATE  IN  ACCOUNTANCY 
UNIVERSITY  OF  ILLINOIS 


Copyright  1919 

BY 

A.  C.  Littleton 


CONTENTS 


Chapter  page 

I Purpose  of  Accounting  3 

II  Transactions  _11 

III  The  Ledger 18 

IV  Trial  Balance  and  Statements 27 

V The  Journal 37 

VI  Special  Books  of  Original  Entry 41 

VII  Direct  Closing  : 14 

VIII  Journal  Closing  52 

IX  Monthly  Adjustments 54 

Assignments 62 


^5  7--''^7X 
L 13^  iTl, 


I 

PURPOSE  OP  ACCOUNTING 

In  beginning  the  study  of  accounting,  it  is  helpful  to  start  witli 
a vision  of  the  end  in  view.  We  may  study  accounting  intending  to 
follow  it  as  a profession  or  to  use  it  as  a stepping  stone  to  other  things 
in  business,  or  we  may  study  it  in  order  as  superintendents,  managers, 
proprietors,  to  use  intelligently  the  accounting  results  others  will 
furnish  us.  But  whether  we  expect  to  ‘ ‘ keep  books  ” or  to  have  them 
kept,  it  is  highly  necessary  to  understand  thoroughly  the  language 
and  methods  of  accounting. 

Financial  Condition.  Accounting  has  for  its  principal  aim,  the 
presentation  of  the  vital  facts  concerning  the  financial  condition  and 
progress  of  a business.  One  of  the  most  important  documents  con- 
taining vital  business  facts  that  is  placed  before  the  business  execu- 
tive or  proprietor  is  the  statement  of  his  financial  condition,  called 
the  Balance  Sheet.  Herein  is  a tabulation  of  all  he  possesses  in  the 
way  of  business  property  and  of  any  claims  there  may  be  against 
that  property. 

If  the  proprietor  owns  all  the  property  he  holds,  the  statement  is 
as  follows : 


BALANCE  SHEET— H.  R.  WELLS 


Property  Possessed 


Cash  $ 7,000 

Land  & Bldg 9,000 

Furniture  800 

Delivery  Car 1,500 


$18,300 


Claims  Against  Property 

H.  R.  Wells,  Propr $18,300 

$18,300 


If,  however,  Mr.  Wells  holds  an  automobile  delivery  car  worth 
$1500  but  has  paid  only  $1000  on  it,  some  one  else  (the  seller)  has  a 
legal  claim  against  the  car  until  the  $500  is  paid  as  well.  Indeed,  the 
seller  would  have  a claim  against  any  or  all  of  the  property  up  to  the 


3 


amount  of  the  unpaid  debt.  In  order  to  present  the  true  condition 
under  these  circumstances,  the  statement  will  have  to  be  as  follows : 


BALANCE  SHEET— H.  R.  WELLS 


Property 

Claims 

Cash  _ _ _ 

Land  & Bldg.  _ _ __ 

Furniture  _ _ _ _ _ 

_ $ 7,000 

9,000 

800 

Blank 

Auto  Co 

500 

Delivery  Car 

. _ 1,500 

$18,300 

H.  R. 

Wells,  Propr 

17,800 

$18,300 

The  above  statement  clearly  shows  that  the  proprietor  claims  what 
ever  portion  of  the  property  is  not  claimed  by  outsiders.  In  fact  one 
of  the  great  services  of  this  statement  of  financial  condition  is  to  ex- 
hibit the  value  of  the  proprietor’s  interest  in  the  property.  This 
value  (often  called  Present  Worth  or  Net  Worth)  is  the  difference 
between  the  total  property  and  the  total  of  claims  by  persons  outside 
the  business.  It  is  to  be  noted  as  a result  of  this  principle  that  the 
total  of  the  claims  column  in  the  Balance  Sheet  will  always  be  equal 
to  the  total  of  the  property  column. 

Business  on  Credit.  We  have  seen  that  the  unpaid  portion  of 
the  automobile’s  purchase  price,  for  example,  constitutes  a debt  to  be 
paid  later,  and' gives  the  seller  who  trusted  Mr.  Wells,  a claim  against 
the  latter’s  property  until  the  obligation  is  discharged  by  payment. 
We  must  see,  also  that  Mr.  Wells  may  sell  as  well  as  buy  on  credit 
(i.  e.  on  trusti) . Assuming  that  he  has  done  so  and  that  certain  persons 
owe  him  $2200  for  goods  sold  them,  then  the  Balance  Sheet  would  be 
as  follows  : 


BALANCE  SHEET— H.  R.  WELLS 


Property 

Cash 

Debts  Receivable 

T.and  & Bldgs 

$ 7,000 
_ 2,200 
_ 9,000 

Claims 

Debts  Payable 

$ 500 

Furniture  _ _ 

Delivery  Car  _ _ _ 

800 

- ■ 1,500 

H.  R.  Wells,  Propr. 

20,000 

$20,500 

$20,500 

Two  points  are  to  be  noticed  in  this  last  statement.  Under  the 
new  conditions  there  was  total  property  of  $20,500  and  there  were 
claims  by  outsiders  of  $500,  leaving  $20,000  as  the  Present  Worth 
of  the  business.  Then  there  is  introduced  the  terms  Debts  Receivable 


4 


and  Debts  Payable."*^  They  are  easily  explained.  If  we  sell  on  credit, 
the  transaction  gives  rise  to  a debt  which  is  receivable  by  us  in  cash 
at  some  later  date ; if  we  buy  on  credit,  the  transaction  gives  rise  to  a 
debt  payable  by  us  at  some  later  date. 

The  fact  that  Mr.  Wells  owes  for  part  of  his  delivery  car  leads  to 
the  suggestion  that  the  statement  would  be  more  interesting  to  the 
proprietor  if  the  names  of  the  people  owed  were  shown.  It  is  impor- 
tant that  he  know  to  whom  he  owes  money  as  well  as  to  know  the 
total  amount;  it  is  equally  important  to  know  from  whom  to  expect 
payments  as  well  as  to  know  the  total  owed  to  him.  Another  revision 
will  therefore  be  made  in  the  Balance  Sheet. 

BALANCE  SHEET— H.  R.  WELLS 
Property  Claims 


Cash  _ 

$ 7,000 

Debts  Payable: 

Debts  Receivable: 

Blank  Auto  Co. 

- -_$  500 

M.  Y.  Jones 

_ $1,700 

P.  J.  Frank 

_ 500 

2,200 

Land  & Bldgs. 

9,000 

Furniture 

800 

Delivery  Car 

1,500 

H.  R.  Wells,  Propr. 

20,000 

$20,500 

$20,500 

With  this  statement  before  him  the  Proprietor  can  view  his  busi- 
ness in  perspective  so  to  speak.  He  can  see  how  his  property  is  divided 
between  Cash,  Debts,  Land,  Equipment,  etc. ; how  outsiders  have  claims 
against  a part  of  his  property;  how  much  property  is  free  from  out- 
side claims  and  therefore  is  his  own.  Because  this  statement  shows 
the  business  man  just  how  he  stands  financially  it  is  regarded  as  a 
very  important  document.  Without  knowing  periodically  just  how 
he  stands,  the  business  man  runs  grave  risks  in  undertaking  large 
purchases  or  in  incurring  large  debts.  Should  he  buy  beyond  his 
ability  to  pay,  he  would  soon  fail  in  business.  He  would  be  wise  to 
look  over  his  statement  before  buying  heavily  and  consider  the  debts 
he  already  has  and  the  extent  of  the  property  at  hand  that  could  be 
used  in  paying  them  or  any  new  ones. 

Profit  and  Loss.  There  is  another  statement  the  business  man 
likes  to  have  presented  periodically;  one  that  permits  him  to  see  the 
Profits  or  the  Losses  the  business  has  experienced. 

*The  terms  here  used  will  be  replaced  at  the  proper  time  by  a more 
technical  phraseology. 


5 


Profit  comes  to  the  merchant  in  buying  at  one  price  and  selling 
at  a higher.  The  man  who  deals  in  large  ventures  like  buying  and 
selling  residence  and  business  real  estate,  for  example,  may  well  calcu- 
late his  profits  on  each  transaction.  His  statement  of  profits  and 


losses  might  be  as  follows : 

Sold  5tli  Street  Property  for $10,000 

Fifth  Street  Property  cost 7,000 

Profit  $ 3,000 

Sold  7th  Street  Property  for 8,000 

Seventh  Street  Property  cost 6,000 

Profit  2,000 

Total  Profits  $ 5,000 


But  the  retail  merchant  selling  clothing,  groceries,  or  hardware 
cannot  follow  the  real  estate  man’s  example.  The  retailer  buys  many 
small  and  different  articles  and  sells  them,  generally,  one  by  one. 
He  cannot  hope  to  keep  records  so  that  he  could  calculate  the  profit 
on  each  separate  article  sold.  So  his  Profit  and  Loss  Statement  must 
consist  of  totals  instead  of  details.  If,  in  a given  period,  he  sells  goods 
to  the  total  value  (at  selling  price)  of,  say,  $7,000,  and  finds  that  these 
goods  cost  $4,000  when  purchased,  there  is  a difference  of  $3,000 
which  is  profit.  In  statement  form  the  facts  would  be  arranged  thus : 

Statement  of  Profit  and  Loss 


Total  Sales $ 7,000 

Total  Cost  of  Purchases* 4,000 

Difference,  Profit  3,000 


Stated  in  another  way.  Profit  is  the  portion  of  the  sales  price 
remaining  after  the  purchase  cost  has  been  recovered.  When  one 
buys  of  us  $7,000  worth  of  merchandise,  he  is  repaying  us  what  we 
paid  for  the  articles  and  something  more — a profit  for  the  service  we 
render  him  in  supplying  the  goods. 

Expense.  If  the  proprietor  employs  a clerk  to  wait  upon  cus- 
tomers, the  selling  price  of  goods  must  be  sufficient  to  repay  not  only 
the  cost  of  the  goods  themselves,  but  the  clerk’s  wages  also,  before 

*The  assumption  is  here  made  that  all  of  the  goods  bought  have  been 
sold;  later  the  case  will  be  considered  in  which  all  of  the  purchases  are  not 
sold. 


6 


there  can  be  any  profit.  Rent  of  store  would  be  like  wages  in  this 
respect.  The  proprietor  pays  Rent  and  Wages,  perhaps,  before  any 
sale  is  made.  He  must  get  back  from  the  customers  enough  to  reim- 
burse him  for  these  payments  before  the  business  can  be  said  to  yield 
him  any  profit. 

When  a business  man  buys  goods  to  sell,  and  pays  wages,  rent, 
etc.  he  pays  out  money  which  he  expects  later  to  recover  through  sell- 
ing goods  to  customers.  He  is  not,  in  making  these  payments,  buying 
permanent  things  like  buildings  or  land  which  last  many  years.  He 
is,  in  a way,  only  putting  his  money  into  goods,  rent,  etc.  temporarily ; 
he  soon  gets  it  back.  Such  payments  may  be  called  by  the  distinctive 
title  of  “Recoverable  Outlays”,  i.  e.  money  “laid  out”  or  paid  out  to 
be  recovered  later. 

We  have  to  note  two  classes  of  Recoverable  Outlays,  namely.  Pur- 
chases and  Expenses.  By  Purchases  we  understand,  “purchases  of 
merchandise  to  be  resold.”  If  a delivery  car  were  bought,  it  could 

^ ‘'O’ 

not  properly  be  classed  as  “Purchases”.  Although  it  was  purchased 
(bought),  it  is  for  use  and  not  for  sale.  To  a dealer  in  automobiles, 
however,  it  might  well  enough  be  classed  as  “Purchases,”  for  in  that 
case  it  would  be  an  article  in  his  stock  in  trade,  bought  for  the  express: 
purpose  of  resale. 

By  Expenses  we  understand  payments  made  for  services  (as  of 
clerks,  buildings,  light  plants,  lawyers,  telephones),  and  for  articles 
consumed  in  the  business  (as  paper,  coal,  gasoline). 

The  cost  of  both  classes  of  outlay  must  be  recovered  before  there 
can  be  any  profit  for  the  proprietor,  and  the  only  source  from  which 
the  costs  can  be  recovered  is  sales.  So,  in  arranging  the  facts  to  form 
a statement  of  Profit  and  Loss,  one  begins  with  the  Sales  and  deducts, 
first,  the  Purchases,  to  show  that  outlay  recovered,  and  then,  from  the 
remainder,  deducts  the  Expenses,  to  show  those  outlays  also  recovered. 
When  all  Recoverable  Outlays  have  been  deducted,  there  remains  the 
proprietor’s  profit.  Accordingly  the  Statement  takes  this  form: 

Statement  of  Profit  and  Loss— H.  R.  Wells 


Sales  $ 7,000 

Purchases  4,000 

Gross  Profit  3,000 

Expenses  800 

Net  Profit  2,200 


Note  the  terms  used  in  the  above  statement.  Gross  Profit  means, 

7 


literally,  Great  Profit ; that  is  to  say,  the  iprofit  before  any  Expenses 
are  recovered;  it  is  the  first  profit,  the  bare  difference  between  the 
selling  prices  and  the  purchase  prices.  Net  Profit  is  the  last -or  final 
profit  after  all  deductions  have  been  made.  It  is  the  amount  the 
proprietor  may  feel  free  to  withdraw  from  the  business  if  -he  wishes. 

With  this  statement  before  him  the  business  man  can  see  why  his 
profit  is  as  it  is.  He  can  see  that,  if  he  could  cut  down  on  Expenses, 
his  net  profit  would  be  greater  and  that  if  Expenses  Increased,  his 
net  profit  would  be  correspondingly  less.  Likewise,  if  he  can  huy 
goods  cheaper  or  increase  his  selling  price,  he  stands  to  gain;  but  if 
sales  have  to  be  made  at  lower  prices  or  purchases  at  higher,  he  stands 
to  gain  less.  Again,  if  he  can  sell  more  goods,  even  at  the  same  price, 
he  can  increase  his  profit,  provided  he  can  keep  the  Expenses  from 
going  up  in  the  same  proportion.  The  statement  gives  him  the  cue  for 
his  next  move. 

Curiously  enough  in  the  study  of  bookkeeping,  the  starting  point 
is  the  end.  It  was  pointed  out  above  that  the  aim  of^accounting  was 
to  present  tlie  vital  facts  concerning  the  financial  condition  of  a busi- 
ness and  its  progress.  The  two  statements  discussed  it  will  be  readily 
seen,  do  present  the  vital  facts  about  a business.  So  here  in  the  Yevy 
beginning  we  are  looking  at  the  end  of  bookkeeping. 

The  question  naturally  following  an  understanding  of  what  the 
statements  are  is.  How  are  they  obtained?  To  have  the  answer  is  to 
have  learned  bookkeeping,  for  bookkeeping  is  the  means  by  which  the 
daily  occurrences  in  a business  are  tabulated  so  that  financial  state- 
ments can  be  readily  prepared  at  frequent  intervals.  The  work  now 
before  us  is  to  build  from  this  foundation  of  a clear  understanding  of 
the  purpose  of  bookkeeping,  so  that  technical  methods  and  systems  of 
recording  shall  be  clearly  related  to  a definite  aim  and  to  each  other. 

PROBLEMS— CHAPTER  I. 

1.  Prepare  the  Balance  Sheet  for  the  Clayton  Hardware  Com- 
pany, owned  by  C.  H.  Clayton  from  the  following  data : Mr.  Clayton 
places  all  the  information  about  his  affairs  at  your  disposal  disclaim- 
ing an}"  knowledge  of  accounting  and  asking  only  that  he  be  given 


8 


a statement  showing*  the  financial  condition  of  his  hardware  business 
on  July  1, — 


Cash  at  the  store $ 100 

Cash  in  bank 1.700 

Cash,  Mrs.  Clayton’s  Savings  Account 300 

Delivery  Automobile  1,200 

Electric  Runabout  2,600 

Stock  of  Hardware 14,000 

Furniture,  etc.,  at  store 900 

Furniture,  etc.,  at  home 3,000 

Residence  11,500 

Owing  to  Hartford  Electric  Company  on  runabout 300 


2.  Show  the  Balance  Sheet  of  H.  R.  Wells,  (page  3)  as  it  would 
stand  after  he  had  lost  his  $6,000  store  building*  by  fire,  assuming  it 
was  uninsured. 

3.  John  Hancock  after  selling  his  business  properties  asks  you 
to  tell  him  what  his  standing  is.  Make  the  statement  to  show  him  the 
facts. 


Cash  $ 2,500 

A.  K.  Smith  owes 157 

J.  C.  Peters  owes 202 

.John  Hancock  owes  to  Parker  Brown 1,200 

John  Hancock  owes  to  Smith  & Debs 850 

John  Hancock  owes  to  Willis  Supply  Co 150 

The  Proprietor  has  borrowed  from  the 

First  National  Bank  1,000 


4.  Compare  the  following*  Balance  Sheet  with  the  one  for  H.  R. 
Wells  on  page  5.  For  each  Balance  Sheet  calculate  the  proportion 
each  item  of  property  is  of  the  total  property  and  the  proportion  each 
item  of  claims  is  of  the  total  claims.  Which  business  would  you  rather 
own,  and  why?  Which  business  would  you  rather  sell  to  and  why? 

BALANCE  SHEET— K.  D.  COATES 


Property  Claims 


Cash  _ _ _ 

$ 500 

Debts  Payable 

6,500 

Debts  Receivable 

5,000 

Land  & Buildings 

13,000 

Furniture.- 

500 

Delivery  Car  __ 

1,500 

K.  D.  Coates,  Propr. 

14,000 

$20,500 

$20,500 

5.  From* the  following  purchases,  sales,  etc.,  select  tlie  proper 
ones  for  the  construction  of  the  Profit  and  Loss  Statement  of  the  busi- 


9 


ness  and  make  the  statement.  The  following  were  purchased  (for 
cash  unless  otherwise  stated)  : , 

Automobile  $ 1,000 

Merchandise  1,200 

Sealskin  Coat  700 

Merchandise  on  credit 1,500 

Services  of  clerk 40 

Services  of  housemaid 30 

Repairs  to  auto 150 

Use  of  store  building 200 

The  following  were  sold  (for  cash  unless  otherwise  stated)  ; 

Merchandise  $ 2,000 

Two  extra  auto  tires  at  cost 50 

Merchandise  on  credit 2,100 

The  children’s  pony 500 

6.  Make  two  similar  Profit  and  Loss  Statements  using  your  own 
figures.  Choose  figures  to  show  that  the  net  profits  of  Business  A as 
compared  with  Business  B are  $2,000  smaller  because  of  bad  manage- 
ment. How  should  A undertake  to  make  a better  showing  in  the 
future  ? 


10 


II 


TRANSACTIONS 

The  financial  condition  of  a going  business  is  constantly  under- 
going changes.  The  amount  of  cash  on  hand,  for  example,  is  seldom 
the  same  two  days  in  succession;  every  payment  and  every  receipt 
changes  it.  If  a number  of  typical  business  occurrences  (often  called 
Transactions)  be  examined  and  their  effect  upon  Property  and  Claims 
noted,  certain  peculiarities  of  accounting  will  become  evident. 

We  shall  assume  that  on  a given  date  the  condition  of  Mr.  Wells  ^ 
business  is  as  set  forth  in  the  Statements  below. 


BALANCE  SHEET— H.  R.  WELLS 


Property 

Debts  payable: 

Cash 

Debts  Receivable: 

$ 7,000 

Blank  Auto  Co. 

_ $ 500 

M.  Y.  Jones  $1,700 

P.  J.  Frank  500 

2,200 

Land  & Bldgs.  _ 

9,000 

Furniture 

Delivery  Car 

800 

1,500 

H.  R.  Wells,  Propr. 

20,000 

$20,500 

$20,500 

STATEMENT  OF  PROFIT  AND  LOSS— H.  R.  WELLS 


Sales  $ 7,000 

Purchases  4,000 

Gross  Profit  3,000 

Expenses  800 

Net  Profit  2,200 


Investment  Transactions.  If  we  may  further  assume  certain 
typical  happenings  (transactions),  the  changes  made  in  the  statements 
because  of  them  can  be  readily  studied. 

1 — Wells,  having  received  $5,000  by  the  will  of  an  uncle,  invests 
this  sum  in  the  business  he  has  been  operating. 

As  soon  as  this  money  has  been  put  in  the  cash  drawer  or  bank 
account  of  the  business,  the  property  available  for  business  purposes 


11 


is  increased.  There  is  now  total  property  of  $25,500  (20,000  plus 
5,000),  since  the  Cash  is  nxade  $12,000.  But  let  it  be  also  noted  that 
this  is  not  the  only  elfect  of  this  additional  investment.  Recall  the 
principle  that  whatever  property  the  business  has  which  is  not  claimed, 
by  outsiders  will  be  claimed  by  the  proprietor.  No  outsider  can  have 
any  claim  against  the  $5,000,  so  it  follows  that  the  proprietor’s  in- 
terest in  the  business  is  the  larger.  To  show  this  state  of  affairs,  the 
item  “H.  R.  Wells,  propr.  ” on  the  right  side  of  the  statement  is  al- 
tered to  read,  $25,000,  (i.  e.  20,000  plus  5,000). 

When  these  two  changes  have  been  made  in  the  statement  it  should 
be  observed  that  the  total  Property  and  the  total  Claims  are  still  equal, 
although  larger  in  amount.  This  equality  of  totals  will  always  be 
true  because  in  expressing  the  changes  made  by  the  transactions,  there 
are  always  two  equal  changes  made. 

2 —  Wells  found  one  morning  that  the  store  had  been  entered  and 
$100  stolen  from  the  cash  drawer. 

Clearly  the  cash  on  hand  is  less  and  the  statement  reflecting  the 
condition  at  this  time  must  show  the  item  Cash  to  be  less.  But  that 
is  not  the  only  change  in  the  situation  worked  by  this  loss.  The  total 
of  Property  is  decreased  although  the  Claims  by  outsiders  remain  un- 
changed; there  is,  therefore  less  property  to  represent  the  proprietor’s 
interest.  The  proprietorship  item  in  the  statement,  then,  should  be 
decreased  to  bring  its  amount  into  harmony  with  the  actual  facts.  In 
this  example  there  has  been  a decrease  to  both  sides  of  the  statement, 
whereas  in  the  preceding  one,  there  was  an  increase  to  both  sides. 

3 —  Wells  pays  $200  in  partial  discharge  of  his  debt  to  Blank  & Co. 

Financial  Transactions.  It  is  easy  to  see  the  effect  of  this  tran- 
saction upon  the  cash ; payment  would  of  course,  decrease  the  Cash. 
Likewise,  part  payment  would  leave  a smaller  debt  to  be  paid  later. 
If  the  statement  is  to  express  the  true  financial  condition  at  this  time. 
Cash  and  Debts  Payable  must  both  be  altered.  This  is  another  example 
wherein  both  sides  of  the  statement  are  decreased. 

4 —  Wells  collects  $500  from  M.  Y.  Jones  in  partial  discharge  of. 
the  latter’s  debt. 

Here  cash  is  increased  by  the  amount  collected  and  Debts  Re- 
ceivable is  decreased.  Partial  payment  by  Jones  leaves  less  debt  “re- 


12 


ceivable”  by  Wells.  This  case  is  seen  to  present  a decrease  to  one  item 
and  an  increase  to  another  on  the  same  side  of  the  statement.  The 
total  Property  is  nowise  changed;  there  has  only  been  a conversion 
of  one  type  of  property  (debt)  into,  another,  (cash). 

5 —  Wells’  bank,  at  his  request,  loans  the  business  $3,000. 

Cash  is  increased,  but  what  other  change  occurs  at  the  same  time  ? 
It  will  have  been  noticed  before  now  that  the  changes  always  occur  in 
pairs. 

Borrowing  always  carries  with  it  the  obligation  or  promise  to 
repay,  so  it  may  be  said  that  a loan  gives  rise  to  debt.  It  is  a transac- 
tion on  credit ; just  as  we  may  buy  merchandise  on  credit.  ‘ ^ Borrow  ’ ’ 
and  ‘ ‘ Loan  ’ ’ are  terms  generally  used  for  transactions  in  cash ; while 
^‘Buy’’  and  ‘‘Sell”  usually  refer  to  transactions  in  merchandise  or 
property  other  than  cash. 

Thus,  while  borrowing  and  buying  on  credit  both  give  rise  to 
debts,  there  still  is  sufficient  difference  between  them  to  warrant  sepa- 
rate accounting.  Therefore,  in  altering  the  statement  for  this  tran- 
saction, a new  item  should  be  introduced  on  the  Claims  side,  namely, 
Loans  Payable.  This  item  is  shown  increased  from  zero  to  $3,000; 
and  again  the  totals  of  the  statement  are  seen  to  be  equal  although 
alterations  have  been  made  in  the  details. 

Recoverable  Outlay  Transactions.  The  investment  transactions 
involved,  among  others,  changes  to  the  Proprietorship  because  the 
occurrences  were  seen  to  alter  the  amount  of  the  owner ’s  claims  against 
the  property.  The  financial  transactions  involved  no  changes  what- 
ever in  Proprietorship,  being  merely  conversions  of  one  property  into 
another,  the  acquisition  of  additional  property  from  outsiders  on  credit 
or  the  application  of  property  to  the  discharge  of  debts.  No  examples 
have  yet  been  studied  which  involved  any  changes  in  Sales,  Purchases, 
or  Expenses.  Some  transactions  of  this  type  will  now  be  examined. 

6 —  Wells  bought  $500  worth  of  merchandise  for  cash. 

Cash  is  decreased  and  that  item  on  the  Balance  Sheet  should  be 
changed  accordingly.  The  other  change  involves  the  Statement  of 
Profit  and  Loss.  There  has  now  been  an  additional  outlay  for  salable 
goods;  it  is  a Recoverable  Outlay,  and,  being  in  the  first  of  the  two 
classes  of  accounts  under  that  heading,  is  designated  Purchases.  If 


13 


the  Statement  is  to  exhibit  the  true  profit,  all  Recoverable  Outlay  must 
be  included.  We  accordingly  alter  the  amounts  to  reflect  this  increase 
in  the  Purchases.  This  transaction,  it  will  be  noted,  expresses  a 
decrease  to  property  (Cash)  and  an  increase  to  Recoverable  Outlay 
(Purchases). 

7 —  Wells  found  that  an  error  had  been  made  in  the  bill  of  goods 
bought  in  transaction  6.  It  now  appears  that  there  was  an  ov- 
erpayment of  $50,  which  amount  is  now  returned  to  Wells  in 
cash  by  the  seller. 

Cash  is,  of  course,  increased.  It  matters  not  what  the  reason 
may  be,  if  more  cash  is  on  hand  after  a transaction  than  before,  that 
transaction  has  caused  an  increase  to  the  cash  item  in  the  statement. 

The  other  change  is  perhaps  not  so  readily  perceived.  A moment ’s 
consideration,  however,  should  show  that  the  Purchases  item  in  the 
Statement  of  Profit  and  Loss  is  incorrect  in  view  of  the  latest  informa- 
tion, although  it  was  thought  to  be  correct  when  the  previous  change 
occurred.  If  Wells  has  received  back  $50  of  what  he  previously  paid 
the  seller,  the  real  cost  of  the  Purchases  is  $450  and  not  $500  as  re- 
corded. Therefore,  alter  the  Purchases  item  in  the  statement  by  $50 
and  the  true  profit  will  result;  otherwise  it  will  be  clearly  incorrect 
and  not  in  accord  with  the  actual  facts.  This  transaction  is  an  ex- 
ample of  the  case  involving  a decrease  to  Recoverable  Outlay.  (Pur- 
chases) and  an  increase  to  Property  (Cash). 

8 —  Wells  paid  rent  of  storeroom  next  to  his  building  used  for 
storage  purposes,  $200, 

Cash  is  decreased;  Recoverable  Outlay  (Expenses)  increased. 
The  true  })rofit  cannot  be  shown  until  this  outlay  or  expense  shall 
have  been  shown  as  recovered  (deducted)  out  of  sales.  So  the  paid 
out  recoverable  costs  are  carried  temporarily  in  their  own  accounts 
and  later  deducted  out  of  Sales  in  a lump  sum. 

9—  Wells  sold  $600  worth  of  goods  to  P.  J.  Frank  on  credit. 

Here  is  an  increase  of  Debts  Recievable  (P.  J.  Frank)  and  an 
increase  to  Outlay  Recovered  (Sales)  : This  new  term  is  in  a way 
the  reverse  of  ‘^Recoverable  Outlay,”  it  expresses  an  accomplished 
fact,  (i.  e.  the  completion  of  a sale)  ; the  latter  term,  however,  looks 
more  toward  the  future  (outlay  to  be  recovered).  One  term  expresses 


14 


the  expectation;  the  other  the  fulfilment.  When  one^4ays  out ’’funds  in 
the  form  of  purchases  of  salable  merchandise  or  for  useful  services,  he 
“expects”  to  get  the  funds  back  eventually;  when  the  goods  are 
actually  sold  at  a reasonable  price,  the  funds  are  then  actually  re- 
covered. It  is  this  idea  accounting  tries  to  express  and  record  in  the 
accounts  .and  transactions  of  this  type. 

The  effect  upon  the  elements  of  the  statements  of  the  nine  tran- 
sactions given  may  be  summarized  as  follows : 

1 —  Increase  Property  (cash)  ; Increase  Proprietorship. 

2 —  Increase  Property  (cash)  ; Decrease  Proprietorship. 

3 —  Decrease  Property  (cash);  Decrease  Outsiders’  Claims  (Debts 
Pay.). 

4 —  Increase  Property  (cash);  Decrease  Property  (Debts  Rec.). 

5 —  Increase  Property  (cash)  ; Increase  Outsiders’  Claims  (Loan 
Pay.). 

6 —  Increase  Recoverable  Outlay  (purchases);  Decrease  Property 
(cash) . 

7 —  Decrease  recoverable  Outlay  (purchases)  ; Increase  Property 
(cash). 

8 —  Increase  Recoverable  Outlay  (expense)  ; Decrease  Property 
(cash) . 

9 —  Increase  Property  (Debts  Rec.)  ; Increase  Outlays  Recovered 
(sales). 

This  summary  should  dispel  any  idea  that  may  have  developed, 
as  it  sometimes  does,  that  one  of  the  two  changes  always  produced  by 
a transaction  is  inevitably  an  increase  to  something  while  the  other  is 
inevitably  a decrease  to  something.  This  is  not  the  fact,  as  a glance 
at  transaction  1,  2,  3,  5,  9,  will  prove.  There  is  no  rule  so  simple  as 
that;  accounting  involves  real  thinking  rather  than  merely  following 
a rule. 

Transaction  Analysis.  The  topic  at  present  under  consideration 
is  one  of  the  most  important  presented  to  the  student  of  elementary 
accounting.  The  stndent  must  learn  to  analyse  business  transactions 
and  to  see  clearly  wliat  the  effect  of  each  one  is  upon  the  various  ele- 
ments of  the  business  enterprise.  If  the  occurrence  produces  an  in- 
crease to  one  element  such  as  Debts  Receivable,  it  must  clearly  per- 
ceived to  be  an  increase.  Ain^  confusion  or  wrong  assumption  will 
surely  l)e  reflected  in  the  statements.  And  if  they  are  wrong,  they 
may  be  wholly  misleading  to  every  one  who  attempts  to  use  them. 

The  (piestion:  WHAT  IS  INCREASED  OR  DECREASED? 
should  be  always  uppermost  in  our  mind  and  should  be  definitely 
answered  before  proceeding  further  with  a given  transaction. 


15 


The  question:  WHAT  OTHER  ELEMENT  IS  INVOLVED? 
should  always  be  answered  also  before  recording  the  change  produced 
by  any  transaction.  It  is  never  to  be  forgotten  that  every  transaction 
produces  two  changes.  Generally  one  of  them  at  least  is  quite  readily 
discovered,  but  often  it  requires  real  thinking  to  perceive  the  other; 
but  it  is  always  there. 

The  nine  typical  transactions  given  above  illustrate  the  method 
of  analysis.  There  is  no  single  rule  which  can  be  applied  equally  to 
any  and  all  transactions;  analysis  is  a method  of  thinking  things  out 
and  not  a method  of  merely  applying  a set  rule.  One  must  have 
clearly  in  mind  the  purpose  of  it  all — the  preparation  of  true  financial 
statements — and  see  to  it  that  no  part  of  his  thinking  shall  lead  up 
to  any  other  kind.  With  the  purpose  always  in  rqind,  he  must  look 
deeply  into  and  behind  the  facts  in  a given  case  to  the  end  that  their 
true  meaning  shall  be  clearly  perceived  and  their  real  effect  upon  the 
elements  which  compose  the  statements  really  understood.  With  the 
transaction  thoroughly  understood  and  the  effect  upon  the  statements 
clearly  in  mind,  no  difficulty  will  be  experienced  in  doing  whatever 
writing  or  other  routine  may  be  necessary. 


PROBLEMS— CHAPTER  II 

1.  Starting  with  the  statements  as  showm  (on  page  11)  and  con- 
sidering the  changes  caused  by  the  several  transactions  thereafter 
discussed,  prepare  statements  to  show  the  standing  of  the  business 
after  all  of  the  transactions  had  occurred. 

2.  For  each  transaction  listed  below,  show  the  kind  of  things 
increased  or  decreased  thereby  in  the  manner  illustrated  (on  page  15). 


1 —  Baldwin  Southmore  began  his  new  business  with  the  invest- 
ment of  $14,000  cash,  $400  worth  of  fixtures  and  $600  deliv- 
ery truck. 

2 —  Bought  a stock  of  merchandise,  $8,000  cash  and  $7,000  on 
credit  from  Harvey  Hart’s  Brothers. 

3 —  Purchased  a second  delivery  car  on  credit  from  the  Storage 
Auto  Company,  $450. 

4 —  Sold  $2,000  worth  of  goods  to  James  Byer  on  credit. 

5 —  Gave  Storage  Auto  Company  merchandise  $450  (selling 
price)  in  discharge  of  debt  to  them. 

6 —  Paid  Rent  of  Store,  $100. 

7 —  Permanently  withdrew  $3,000  of  original  investment,  taking 
$2,000  in  cash  and  $1,000  in  merchandise  (at  cost  price), 

8 —  Accepted  a good  office  safe  worth  $300  to  apply  against 
Byer’s  debt. 

9 —  $500  worth  of  goods  from  Hart’s  Brothers  are  not  up  to 
standard  quality  and  have  been  returned  to  them. 

16 


10 —  A small  fire  destroyed  one  of  the  delivery  cars.  It  was  the 
originally  invested  one  and  was  not  insured. 

11 —  Borrowed  $2,000  from  the  bank. 

12 —  Paid  Hart’s  Brothers  $1,000  on  account. 

13 —  Paid  wages  for  two  weeks,  $80. 

14 —  Sold  remaining  merchandise  for  a $15,000  residence  property 
and  $8,000  cash. 

15 —  Paid  $1,500  on  loan  from  the  bank. 


3.  Produce  the  statements  for  Soiitlimore ’s  business  as  it  stood 
after  the  15th  transaction. 


JV 


Ill 


THE  LEDGER 

In  the  previous  discussions,  two  principles  stand  out  clearly : 
first,  that  the  aim  of  accounting  is  to  make  Financial  Statements 
])ossible,  and  second,  that  the  statements  of  one  day  would  be  out  of 
date  the  next  because  of  the  business  transactions  which  had  taken 
])lace  in  the  meantime.  The  problem  next  to  receive  consideration  is 
this : How  does  accounting  provide  the  means  of  recording  transac- 
tions so  that  statements  may  be  prepared  at  comparatively  long  inter- 
vals ? 

It  will  be  readily  seen  that  the  procedure  outlined  in  the  last 
chapter  could  hardly  be  practiced  in  actual  business.  While  every 
separate  transaction  may  be  shown  to  produce  definite  changes  in  the 
statements  and  thus  to  help  us  perceive  the  effect  of  transaction  upon 
the  business,  yet  to  attempt  in  practice  to  record  many  transactions 
by  successive  alterations  of  the  statements  would  soon  lead  to  confusion. 
The  ])roprietor  will  want  his  statements  only  at  certain  definite  inter- 
vals, say  at  the  end  of  each  month,  and  some  orderly  method  there 
must  be  for  systematically  recording  what  happens  during  the  month 
so  statements  can  be  prepared  when  needed  without  delay  or  confusion. 

The  problem  accounting  has  to  meet  involves  several  factors. 
Provision  must  be  made  for  expressing  easily  and  without  danger  of 
confusion,  every  possible  change  in  any  of  the  several  elements  of  the 
statements ; space  there  must  be  for  recording  the  changes  occurring 
in  a period  of  some  length ; care  must  be  taken  to  minimize  errors 
in  dealing  with  the  many  figures. 

The  Account.  Perhaps  the  first  suggestion  coming  naturally  to 
mind  upon  considering  the  factors  in  this  problem  would  be  that  the 
statements  be  spread  upon  a sheet  sufficiently  large  to  permit  amounts 
to  be  neatl}"  added  to  and  deducted  from  the  separate  items.  But 
only  a sheet  of  unreasonable  size  could  take  care  of  any  but  the  smallest 
business.  The  next  idea  advanced  might  well  be  that  a page  in  a book 
or  a part  of  a page,  be  assigned  to  each  of  the  several  elements  of  the 
statements.  Thus  there  could  be  a Cash  Page,  a Purchase  Page,  etc. 


18 


Transactions  which  increased  Cash  could  easily  be  added  to  the  pre- 
vious figures  and  deductions  subtracted. 

Part  of  the  problem  seems  solved,  for  changes  could  be  easily 
recorded  on  the  separate  pages  without  confusion  and  there  would 
be  space  for  a considerable  period  with  the  opportunity  of  carrying 
the  work  forward  to  other  pages  when  on  was  filled.  But  if  notice 
be  taken  of  the  great  number  of  small  problems  in  subtraction  and 
addition  that  would  be  necessary,  it  will  be  seen  that  little  provision 
has  been  made  for  minimizing  the  errors  naturally  attendant  upon 
such  arithmetic. 

We  see  at  once  that  a change  in  the  elements  of  a business  could 
be  in  only  two  directions — increase  or  decrease.  The  cash,  for  example, 
could  be  only  added  to  or  subtracted  from.  Therefore,  the  idea  comes 
to  mind  at  once  that  most  of  the  adding  and  subtracting  of  separate 
transactions  could  be  eliminated  by  dividing  the  page  vertically  down 
the  -middle  and  recording  on  one  side  only  those  transactions  which 
increased  the  total  of  that  page  and  on  the  other  only  the  decreasing 
transactions. 

The  Cash  Page  if  kept  thus  would  look  like  this: 


Cash 


(Increase  side) 

(Decrease  side) 

June 

1 — Balance  on  hand  at 

June 

1 — to  Marvel  Flour  Mills  $900 

beginning 

$5,000 

June 

3 — to  Hart  Produce  Co.__ 

600 

June 

7 — from  Smith  & Co. 

700 

June 

4 — to  clerk  for  wages 

75 

June 

9 — from  A.  J.  Jones__ 

500 

June 

7 — to  landlora  for  rent__ 

200 

June 

13— from  R.  P.  Clark__ 

300 

June 

17 — from  H.  T.  Peters_- 

800 

In  this  arrangement  we  have  an  account : in  a way,  a story. 
A narrative  is  sometimes  called  ‘‘an  account;’’  the  above  example  is 
really  a narrative  of  the  changes  occurring  in  the  Cash,  hence  the 
title,  Cash  ‘‘Account.”  Other  account  names  are  given  in  the  same 
way. 

That  the  arrangement  of  financial  facts  in  account  form  really 
decreases  the  chance  of  arithmetical  error  will  be  apparent  in  the 
above  example.  In  order  to  find  the  amount  of  cash  on  hand  on  the 
last  day  shown,  (1)  add  together  the  entries  on  the  left,  (2)  add 
together  the  entries  on  the  right,  (3)  subtract  the  smaller  of  the  two 
sums  from  the  larger.  The  result  will  be  the  Balance  of  Cash  on 
June  17.  Compared  to  these  three  simple  steps,  if  one  successively 
added  and  subtracted  each  entry  from  the  opening  Balance,  there 


19 


would  be  eight  calculations  to  be  performed,  each  one  offering  a chance 
of  error.  There  is  a saving  too,  in  time  in  the  account  form  because 
of  the  fewer  calculations. 

The  Ledger.  If  each  item  on  the  Financial  Statements  be  given 
a page  or  part  of  a page  in  this  manner,  the  result  would  be  a book 
of  accounts  which  we  term  a Ledger.  In  some  languages  the  term 
is  equivalent  to  ‘^Principal  Book,”  which  describes  it  very  aptly. 

The  next  problem  is  to  get  the  Ledger  started  or  ‘‘opened”  as  the 
accounting  term  has  it.  The  process  of  opening  the  Ledger  would 
seem  simple  enough — merely  heading  up  the  pages  and  entering  the 
amounts  as  shown  on  the  first  statement* — if  it  were  not  for  the  fact 
that  one  must  decide  on  which  side  of  the  vertical  ruling  to  enter  the 
first  amounts  or  opening  Balances. 

This  will  require  some  little  explanation  and  no  little  study  to 
make  it  clear.  First,  a rough  outline  sketch  of  the  Ledger  will  be 

fThe  first  statements,  if  no  accounting  books  had  been  kept,  would  have 
to  be  compiled  from  an  inspection  and  valuation  of  the  property  and  by 
reference  to  whatever  unrelated  memoranda  were  available. 


20 


sliown  coiitaiiiiiig  as  opening  entries,  the  amounts  given  in  H.  K. 
Wells’  statements  on  page  11  above. 

H.  R.  WELLS  LEDGER 


Cash 


Blank  Auto  Co. 


$7,000 


$ 500 


M.  T.  Jones 


H.  R.  Wells — Propr. 


$1,700 


$1,200 


P.  J.  Frank 
$500 

Land  and  Bldgs. 

$10,000 


Store  Furniture 


$800 


Delivery  Auto 


$1,500 


Purchases 


Sales 


$4,000 


$7,000 


Expenses 


$800 


21 


The  point  to  be  explained  is  why  some  of  the  opening  balances 
are  on  the  left  while  others  are  on  the  right. 

By  leaving  a blank  space  in  the  above  Ledger  (in  a book  it  might 
be  several  pages)  a division  is  marked  between  the  accounts  which 
come  from  the  Balance  Sheet  and  those  which  come  from  the  State- 
ment of  Profit  and  Loss.  By  comparing  the  first  section  of  the  Ledger 
with  the  Balance  Sheet,  it  will  be  observed  that  all  of  the  amounts  on 
the  left  (Property)  side  of  the  latter  became  opening  entries  on  the 
left  side  of  the  accounts  in  the  Ledger;  all  of  the  amounts  on  the 
right  (Claims)  side  became  opening  entries  on  the  right  side  of  the 
Ledger  accounts.  This  arrangement  prevails  not  by  coincidence  but 
by  intention.  We  shall  wish  later  to  produce  a Balance  Sheet  from 
the  facts  in  the  Ledger.  It  will  aid  us  in  transcribing  correctly  the 
amounts,  if  they  are  found  in  the  Ledger  on  the  same  side,  left  or  right, 
as  they  are  to  be  placed  on  the  Balance  Sheet.  Hence,  in  opening 
the  Ledger  for  the  first  time,  the  amounts  are  intentionally  placed 
as  shown  above. 

The  arrangement  of  the  opening  entries  coming  from  the  State- 
ment of  Profit  and  Loss  is  not  so  readily  explained.  But  it  can  be 
placed  on  a basis  similar  to  the  first  part  of  the  Ledger  by  referring 
to  the  older  form  of  Profit  and  Loss  Statement. 

It  was  the  custom,  until  recent  years,  to  report  the  Statement 
of  Profit  and  Loss  in  the  following  form: 

STATEMENT  OF  PROFIT  AND  LOSS  (old  form) 

Purchases $4,000  Sales  $7,000 

Expenses  800 

$4,800 

Balance  being  Net  Profit 2,200 

$7,000  $7,000 

This  original  form  of  the  Profit  and  Loss  Statement  is  seen  to 
conform  to  the  arrangement  of  the  Balance  Sheet  by  having  the  facts 
tabulated  in  two  columns,  left  and  right.  One  using  this  style  of 
statement  would  find  it  an  aid  in  transcribing  the  facts,  if  the  figures 
were  to  be  found  in  the  Ledger  on  the  same  side  as  they  were  to  appear 
on  the  statement.  In  opening  the  Ledger,  then,  the  amounts  are 
intentionally  entered  as  shown  in  the  Ledger  above.  Purchases  and 
Expense  balances  on  the  left  and  Sales  on  the  right. 

Classification  of  Accounts.  With  the  Ledger  opened,  the  next 
point  concerns  itself,  with  making  additional  entries  therein  to  record 

22 


the  financial  changes  that  take  place.  The  first  question  would  logi- 
cally be ; Which  side  of  these  accounts  receives  the  increases  and 
which  the  decreases  as  the  transactions  are  entered? 

This  is  easily  answered  for  those  accounts  which  enter  the  Ledger 
when  it  is  first  opened : Any  increase  would  be  entered  on  the  same 
side  as  the  opening  balance;  any  decrease,  on  the  side  opposite  the 
opening  balance.* 

After  a Ledger  has  been  opened,  however,  new  accounts  are  begun 
as  occasion  requires,  and  for  these  there  must  be  some  way  of  deter- 
mining the  increase  and  decrease  side.  All  accounts  are  divisible 
into  classes  and  according  as  one  account  falls  into  one  class  or  another, 
its  plus  and  minus  characteristics  are  determined.  So  the  quickest 
wa}^  to  get  at  the  matter  is  to  learn  how  accounts  are  classified  into 
groups  and  to  learn  to  recognize  new  accounts  by  assigning  them  to 
their  appropriate  group. 

Tlie  first  subdivision  of  accounts  marks  out  two  great  classes : 

I.  Real  accounts. 

II.  Nominal  accounts. 

Every  account  belongs  under  one  of  these  two  heads.  Any  account 
which  may  properly  be  shown  in  the  Balance  Sheet  is  a Real  account 
for  it  usually  stands  for  some  real,  existing  thing,  or  some  lawful 
enforcible  right : as  Cash,  stands  for  money  in  the  drawer.  Furniture, 
for  the  desks,  etc.,  or  as  Debts  Receivable  stand  for  the  enforcible 
right  to  have  the  debt  paid.  Any  account  which  may  properly  be 
shown  in  the  Profit  and  Loss  Statement  is  a Nominal  account,  for  it 
represents  not  a thing  but  a name — a mere  idea.  Sales,  for  example, 
does  not  call  to  mind  any  actual  thing  as  would  Cash ; it  calls  to  mind 
only  a ''goods-sold-idea”,  if  we  may  so  express  it.  Expense  ealls  to 
mind  a ‘ ‘ services-consumed-idea.  ’ ’ A sale  is  not  a thing  like  Cash 
or  a right  like  a Debt,  but  merely  a count  of  ‘‘disposed-of-merchan- 
dise.”  Expense  is  merely  a count  of  ‘ Lised-up-services.  ” 

Each  of  these  groups  is  in  turn  divided, 

I.  Real  accounts. 

1.  Assets.  2.  Liabilities. 

II.  Nominal  accounts. 

1.  Recoverable  Outlays.  2.  Recovered. 

The  subdivisions  of  Group  II.  are  already  familiar,  but  the  sub- 

*This  peculiar  practice  in  accounting  of  expressing  a subtraction  by  an 
opposing  entry  should  never  be  lost  sight  of. 

23 


division  of  Real  accounts  (Group  1.)  reveals  two  new  names.  “As- 
sets” is  a technical  term,  the  nearest  synonym  for  which  is  Property. 
Thus  in  a technically  correct  Balance  Sheet  (and  Ledger  as  well) 
certain  elements  are  termed  Assets  which  we  have  called  Property 
until  now.  By  an  Asset  we  will  now  understand  any  valuable  thing 
or  right  which  is  serviceable  to  the  operation  of  business  or  which 
possesses  value  in  the  sense  that  cash  could  be  obtained  for  it. 

The  term  “Liabilities”  is  now  to  replace  “Claims”  in  our  state- 
ments to  make  them  technically  correct.  The  two  terms  have  much 
the  same  significance ; the  difference  is  largely  one  of  point  of  view. 
A debt  that  we  shall  soon  have  to  pay  may  be  regarded  as  a Liability, 
(i.  e.  as  an  obligation,  a burden),  or  as  a Claim  (i.  e.  a right  another 
has  against  us),  depending  upon  whether  we  choose  to  look  at  it  from 
our  own  point  of  view  or  from  another’s.* 

A diagram  will  help  to  get  these  matters  related  in  our  minds 
in  an  orderly  manner.  The  Ledger  may  be  represented  as  the  two 
statements  greatly  expanded  as  to  space. 

LEDGER 

REAL  ACCOUNTS — (i.e.,  Balance  Sheet  accounts) 

Asset  Accounts  Liability  Accounts 


NOMINAL  ACCOUNTS — (i.e.,  Profit  and  Loss  Statement  accounts) 
Recoverable  Outlay  Accounts  Outlays  Recovered  Accounts 


*Proprietorship  is’  clearly  recognized  as  a claim  against  assets,  but 
there  are  those  who  profess  inability  to  conceive  of  it  as  a liability  of  the 
business.  The  average  business  man,  however,  and  the  average  student 
experiences  no  difficulty  in  thinking  of  the  Business  as  distinct  from  the 

24 


Increases  and  Decreases.  The  important  characteristics  of  these 
several  classes  of  accounts  now  to  be  stated  should  be  thoroughly 
learned  and  every  effort  made  to  use  them  consistently  in  subsequent 
exercises. 

All  accounts  representing  Assets  or  Recoverable  outlays  are  in- 
creased by  entries  on  the  left  side  and  decreased  by  entries  on  the 
right. 

All  accounts  representing  Liabilities  and  Outlays  Recovered  are 
increased  by  entries  on- the  right  side  and  decreased  by  entries  on  the 
left. 

Although  the  above  statement  of  principle  should  be  memorized^ 
the  following  arrangement  may  help  to  call  the  facts  to  mind. 


All  Asset 

Accounts 

All  Liability  Accounts 

+ 

— 

— 

+ 

Left 

Right 

Left 

Right 

All  Recoverable 

Outlay  Accounts 

All  Outlays  Rec 

overed  Accounts 

+ 

— 

— 

+ 

Left 

Right 

Left 

Right 

By  applying  these  principles  it  will  now  be  possible,  not  only 
to  open  a Ledger  if  required,  but  also  properly  to  make  subsequent; 
entries  therein  to  record  any  changes  that  occur  in  the  elements  of  the 
business  thereafter.  The  Ledger  will  then  become  a concise  but  very 
complete  record  of  the  condition  and  progress  of  the  business. 

Entries.  AVhen  preparing  to  make  entries  after  the  Ledger  has 
been  opened,  one  must  answer  three  questions  regarding  each  tran- 
saction : 

1.  Which  two  accounts  are  changed  by  this  transaction? 

2.  Are  those  accounts  increased  or  decreased? 

Proprietor  and  therefore  can  clearly  conceive  of  the  Business  (typified  by 
the  Balance  Sheet)  as  liable  to  the  Proprietor  for  his  Invested  Capital  and  the 
accumulated  profits.  But  it  should  never  be  overlooked  that  the  Proprietor’s 
claim  is  always  secondary  to  that  of  outside  creditors. 

25 


3.  Does  the  entry,  therefore,  fall  upon  the  left  or  right  side? 

The  first  two  questions  can  be  answered  only  b}"  thinking  over 
the  accounts  in  use  and  the  meaning  of  the  transaction.  If  the  sever- 
al accounts  being  used  do  not  come  readily  to  mind,  a list  of  them 
should  be  looked  over  and  the  proper  ones  involved  chosen  therefrom. 

The  meaning  of  the  transaction  must  be  understood  perfectly  or 
correct  entries  will  be  impossible.  Tf  it  is  said  that  a delivery  car  is 
purchased  it  must  l)e  clearly  perceived  that  the  element  of  the  business 
called  Delivery  Equipment  is  increased  and  not  Purchases.  The  latter 
is  a technical  term  meaning  ^‘Purchases  of  merchandise  for  re-sale 
only;”  it  is  not  so  broad  in  meaning  in  accountancy  as  in  ordinary 
conversation.  Should  the  car  be  sold  later.  Delivery  Equipment 
would  be  decreased,  for  the  accounts  must  always  show  by  their  bal- 
ances the  present  state  of  affairs. 

Tf  the  transaction  states  that  a Debt  Receivable  or  a Debt  Pay- 
able is  paid  we  must  understand  that  ‘‘paid”  does  not  always  refer 
to  cash.  The  word  is  more  in  the  sense  of  “discharged”  and  there- 
fore may  be  used  to  indicate  a decrease  to  Debts  from  whatever  cause. 
Thus  goods  returned  could  cause  a decrease  to  Debts  as  properly  as 
could  cash ; a ])romissory  note  would  discharge  a previously  contracted 
debt  by  taking  the  place  of  the  oral  agreement.  These  examples 
suffice  to  show  that  transactions  must  be  studied  thoughtfully. 

As  one  gains  experience  in  anal3osing  transactions,  the  customary 
and  oft  repeated  ones  grow  very  familiar,  and  interpretation  is  very 
easy.  But  new  and  unfamiliar  transactions  are  constantly  coming  to 
notice  which  must  be  reasoned  out  step  by  step  as  suggested. 

AVith  the  first  two  (piestions  satisfactorily  covered,  the  third  can 
be  answered  by  referring  the  transaction  to  the  rules  of  increase  and 
decrease  given  in  connection  with  the  classification  of  accounts.  One 
needs  only  decide  to  which  class  belong  the  accounts  in  question  1 
and  recall  whether  the  increases  to  that  class  fall  upon  the  left  or  tin' 
right  side.  So  to  decide  necessitates*  a thorough  understanding  of  the 
characteristics  of  each  class  of  accounts  as  given  in  a previous  chapter 
and  an  abilitj^  instantly  to  recall  the  general  rule  of  plus  and  minus. 


PROBLEMS— CHAPTER  III. 

1.  Analyse  the  several  typical  transactions  for  H.  R.  AVells’ 


26 


business  in  Chapter  11  to  determine  which  side  of  the  accounts  sliould 
receive  the  entry  for  each.  Show  a list  of  transactions  thus : 

Left  side  of  Right  side  of 

(1)  account  $xxxxx;  account  $xxxxxx 

(2)  account  $xxxxx;  account  $xxxxxx 

etc. 

2.  Follow  instructions  in  Problem  1.  above,  but  use  the  transac- 
tions  for  Problem  2.  following  Chapter  II. 

3.  Open  a Ledger  for  Baldwin  Southmore’s  business  using  not 
more  than  a half  dozen  lines  to  an  account,  and  enter  therein  the 
transactions  analyzed  in  Problem  2 above. 


lY. 

TRIAL  BALANCE  AND  STATEMENTS 

In  an  earlier  chapter  we  saw  how  the  statements  were  made  in  a 
form  to  show  a left  and  a right  side  with  equal  totals.  We  will  take 
another  example. 


BALANCE  SHEET— H.  K.  BROWN 


Assets  Liabilities 


Cash 

. - $ 800 

Debts  Payable 

. $1,100 

Debts  Receivable 

1,200 

Notes  Payable 

300 

Notes  Receivable 

700 

Lands  and  Bldgs. 

_ _ 3,500 

Delivery  Equipment 

900 

Store  Fixtures 

200 

*H.  K.  Brown,  Capital 

5,900 

$7,300 

$7,300 

*A  new  term  is  here  introduced.  The  Proprietor’s  claim  against  the 
assets  is  termed  his  Capital  Investment,  or  simply  his  Capital.  It  is  ordi- 
narily the  amount  he  put  in  originally  to  start  the  business.  It  may  be 
increased  by  putting  in  more  property  of  any  kind,  or  decreased  by  taking 
property  away  permanently.  To  be  technically  correct  his  account  in  the 
ledger  should  be  headed  as  here  shown  in  the  balance  sheet. 


27 


A Ledger  opened  from  these  facts  would  also  present  equal  totals 
as  the  example  will  show. 


Cash  Debts  Payable 


$800 

$1,100 

Debts  Receivable 

Notes  Pay. 

$1,200 

$ 300 

Notes  Receivable 

H.  K.  Brown,  Cap. 

$700 

$5,900 

Land  and 

Buildings 

$3,500 

Delivery  Equipment 

$900 

Fixtures 

$200 

Purchases 

Sales 

Exp 

ense 

$7,300,  Total  of  entries  on  left.  Total  of  entries  on  right,  $7,300 


If  we  were  now  to  reverse  the  process  and  take  olf  a list  of  the 
accounts  and  amounts  shown  by  the  Ledger,  we  would  have  simply 


28 


the  Balance  Sheet  again  bnt  without  its  headings.  The  nominal  ac- 
counts are  blank  because  no  transactions  have  occurred  to  cause  en- 
tries to  them. 

Let  us  analyse  a few  transactions,  enter  them  in  the  Ledger  and 
note  the  effect  upon  the  quality  of  the  totals. 

Transactions 

1 —  Collected  cash  $200  from  a Debt  Receivable. 

2 —  Paid  cash  $100  on  a Debt  Payable. 

3 —  Bought  merchandise  on  credit  $700. 

4 —  Paid  clerk  $40  for  wages. 

5 —  Sold  all  of  the  merchandise  for  cash,  $1200. 

These  transactions  analysed  as  outlined  in  the  previous  chapter 
will  show  certain  accounts  increased  and  others  decreased;  some  en- 
tries for  these  transactions  would  be  to  the  left  side  of  the  accounts, 
some  to  the  right.  Arranged  in  tabular  form,  the  analysis  gives  the 
following  results : 


Entry  on  left  Entry  on  Right 


Trans. 

1 — Cash  _ _ 

_ $ 200 

Debts  Rec. 

$ 200 

Trans. 

2 — Debts  Pay. 

- 100 

Cash  _ 

100 

Trans. 

3 — Purchases 

. _ _ 700 

Debts  Pay. 

700 

Trans. 

4 — Expense  _ _ 

40 

Cash 

40 

Trans. 

5 — Cash  _ . 

. _ _ 1,200 

Sales  _ _ 

1,200 

29 


Transactions  Entered.  From  this  tabulation  it  is  an  easy  step 
to  enter  the  facts  in  the  Ledger,  which  will  then  appear  as  follows : 


Cash  Debts  Payable 


Original 
Trans.  1 
Trans.  5 

$ 800 
200 
1,200 

Trans.  2 
Trans.  4 

$100 

40 

Trans.  2 $ 100 

Original 
Trans.  3 

$1,100 
$ 700 

Debts  Receivable 

Notes  Payable 

Original 

$1,200 

Trans.  1 

$ 200 

Original 

$ 300 

Notes  Receivable 

H.  K.  Brown,  Capital 

Original 

$ 700 

Original 

$5,900 

Land  and  Buildings 

Original 

$3,500 

Delivery  Equipment 

Original 

$ 900 

Fixtures 

Original 

$ 200 

Purchases 

Sales 

Trans.  3 

$ 700 

Trans.  5 

$1,200 

Expense 

Trans.  4 

$ 40 

80 


Now  to  test  the  equality  of  totals  after  entries  have  been  niach* 
the  following'  list  is  prepared  from  the  Ledger  as  it  stands ; 


LIST  OF  ACCOUNTS 
Left  Side 


Cash  $2,200 

Debts  Receivable  1,200 

Notes  Receivable  700 

Land  and  Buildings 3,500 

Delivery  Equipment  900 

Fixtures  200 

Purchases  700 

Expense  40 

Debts  Payable 100 

Notes  Payable 


H.  K.  Brown,  Capital 
Sales  


Right  Side 
$ 140 
200 


1,800 

300 

5,900 

1,200 


$9,540  $9,540 


The  totals  are  seen  to  be  equal.  It  is  but  another  illustration 
of  the  old  proposition  that  equals  added  to  equals  produce  equals.  If 
we  take  the  totals  of  the  Balance  Sheet,  or,  what  is  the  same  thing,  the 
totals  of  the  Ledger  just  after  opening,  and  to  them  add  the  totals  of 
the  transactions  as  they  were  tabulated  above  we  would  have  the  totals 
of  the  Ledger  after  the  transaction  entries  were  made,  i.e.  the  totals 
just  derived  in  the  above  list  of  accounts. 


Left  Right 

Totals  in  Ledger  at  opening $7,300  $7,300 

Transaction  totals 2,240  2,240 


Totals  in  Ledger  after  entries $9,540  $9,540 


Where  business  transactions  are  numerous  and  the  Ledgers  large, 
such  a test  of  the  entering  is  a frequent  necessitvv  Figures  may 
easily  be  copied  incorrectly  or  even  entered  on  the  wrong  side  of  the 
account.  This  causes  the  Ledger  record  to  contain  untrue  statements 
of  fact  and  occasional  tests  are  advisable  in  order  that  errors  ma.y 
be  detected  and  corrected. 

The  list  of  accounts  which  affords  this  test  is  given  the  technical 
name  of  Trial  Balance.  It  is,  indeed,  a trial  of  the  Ledger  to  see 
if  it  is  in  Balance  or  equilibrium,  that  is,  in  a condition  of  ecjuality 
of  totals.* 

*It  is  often  thought  desirable  to  list  in  the  Trial  Balance  only  the  bal- 
ances of  the  several  accounts  rather  than  both  sides.  This  is  perfectly 
proper  once  the  theory  of  the  Trial  Balance  is  thoroughly  understood. 

See  also  footnote,  page  33. 


31 


Debit  and  Credit.  We  are  to  note,  in  passing,  two  other  techni- 
cal terms  much  used  throughout  accounting.  It  will  have  been  noticed 
that  the  left  and  right  sides  of  the  Balance  Sheet,  of  the  accounts,  of 
the  Trial  Balance,  etc.  often  enter  into  the  discussion.  Custom  has 
assigned  the  name  Debit  to  the  left  side  wherever  it  appears  and 
Credit  to  the  right  side.  Thus,  for  example,  we  speak  of  the  debit 
side  of  the  Cash  account,  referring  thereby  to  the  left  side;  we  refer 
to  the  right  side  of  the  Sales  account  always  by  the  term  credit  side. 
Sometimes  the  terms  are  abbreviated — Dr.  and  Cr.  These  terms  are 
decidedly  convenient  because  of  the  ease  with  which  they  may  be  used 
as  noun,  adjective  or  verb.  We  may  say : This  is  the  debit  side  of  the 
account,  using  ‘‘debit”  as  an  adjective  to  define  “side”.  We  may 
say : This  is  a debit  for  the  Cash  account,  meaning  an  item  which 
must  be  entered  on  the  left  (debit)  side  of  Cash.  Here  the  term  is 
used  as  a noun.  Again,  it  may  be  used  as  a verb  to  indicate  an  action, 
as  when  we  say : I debit  this  to  Purchase  account,  meaning,  I place 
this  upon  the  debit  side  of  the  account. 

Because  Debit  invariably  refers  to  the  left  and  Credit  to  the  right 
and  because,  as  we  have  seen,  the  two  sides  of  the  Balance  Sheet  are 
always  equal  as  well  as  the  two  sides  of  the  transaction,  the  two  sides 
of  the  Ledger  and  of  the  Trial  Balance,  we  are  not  surprised  to  find 
in  accountancy  an  axiom  which  states — 

Debits  and  Credits  are  always  equal. 

This  axiom  has  a more  important  bearing  later  than  just  now,  for 
later  we  shall  see  transactions  which  involve  one  debit  and  two  credits ; 
the  two  credits  added  must  be  equal  to  the  debit. 

The  Statements.  Besides  affording  a ready  test  of  the  accuracy 
with  which  amounts  have  been  entered  to  the  debit  and  credit  of  the 
accounts,  the  Trial  Balance  is  a convenient  summary  of  the  contents 
of  the  ledger  from  which  to  construct  the  financial  statements  at  the 
end  of  a period. 

We  have  to  conceive  of  the  Ledger  as  a single  page  statement 
expanded  into  a book  and  as  being  subject  to  constant  change  from 
the  entries  therein.  The  form  never  changes;  only  the  amounts. 
The  Ledger,  then,  is  ready  at  all  times  to  be  reconverted  into  state- 
ments, which  statements  shall  reflect  the  changes  occurring  since  the 
Ledger  was  opened  or  since  the  last  statements  were  prepared.  The 


32 


Trial  Balance,  then,  being  a summary  of  the  Ledger,  contains  all  of 
the  elements  necessary  to  form  the  new  statements.Indeed,  the  state- 
ments are  bnt  the  Trial  Balance  items  re-gronped  to  form  the  Balance 
Sheet  and  the  Profit  and  Loss  Statement. 

A good  method  of  procedure  in  transforming  a Trial  Balance  into 
the  financial  statements  is,  first,  to  mark  in  the  margin  opposite  eacli 
item  a letter  to  indicate  the  class  of  accounts  it  belongs  to.  If  we 
use  for  Asset,  “L”  for  Liability,  ''RO”  for  Recoverable  Outlay, 
and  ^‘Rd”  for  Outlays  Recovered,  H.  K.  Brown’s  Trial  Balance  would 
be  marked  as  follows : 

TRIAL  BALANCE— H.  K.  BROWN* 

Dr.  Cr. 

$2,060 
1,000 
700 
3,500 
900 
200 
700 
40 

$1,700 
300 
5,900 
1,200 

$9,100  $9,100 

With  the  Trial  Balance  thus  marked  in  the  margin  it  is  not  a 
difficult  matter  to  assemble  all  items  marked  ^^A”  into  one  column 
and  those  marked  ‘‘L”  into  a parallel  column,  with  proper  headings, 
to  form  the  Balance  Sheet.  It  will  be  observed  that  in  lettering  the 
Trial  Balance  we  must  have  very  clearly  in  mind  the  distinction 
between  Real  and  Nominal  accounts  and  between  the  four  subclasses 
of  accounts  so  that  each  item  will  be  properly  labled. 

When  the  Real  accounts  have  been  transferred  from  the  Trial 
Balance  to  the  Balance  Sheet,  taking  care  to  check  off  each  item  as 
transferred  so  none  shall  be  missed,  then  the  Profit  and  Loss  State- 
ment is  constructed  from  the  Nominal  accounts.  When  that  is  com- 
pleted, see  that  all  accounts  on  the  Trial  Balance  are  checked  as  trans- 
ferred. Remember,  too,  that  the  old  form  of  Profit  and  Loss  State- 
ment, while  an  excellent  aid  in  making  explanation  of  theory,  is  no 
longer  the  preferable  arrangement. 

♦Where  statements  are  to  be  made  from  the  Trial  Balance,  as  is  the 
usual  case,  it  is  well  to  have  the  Trial  Balance  consist  of  account  balances 
rather  than  both  sides  of  each  account. 


A Cash  

A Debts  Receivable  

A Notes  Receivable 

A Land  and  Buildings  . 
A Delivery  Equipment 

A Fixtures  

RO  Purchases  

RO  Expense 

L Debts  Payable  

L Notes  Payable 

L H.  K.  Brown — Capital 
Rd  Sales 


33 


Following  these  suggestions  the  statements  from  the  above  Trial 
Balance  would  be  as  follows : 


BALANCE  SHEET— H.  K.  BROWN 
Assets 

Cash $2,060 

Debts  Receivable  1,000 

Notes  Receivable  700 

Land  and  Buildings 3,500 

Delivery  Equipment 900 

Fixtures  200 


Liabilities 

Debts  Payable $1,700 

Notes  Payable 300 

H.  K.  Brown,  Propr. 5,900 


$8,360  $7,900 

PROFIT  AND  LOSS  STATEMENT 

Sales  $1,200 

Purchases  700 


Gross  Profit 
Expenses  __ 


500 

40 


Net  Profit 


460 


Profit  and  Capital.  It  will  be  observed  that  the  Beal  accounts 
from  the  Trial  Balance  are  not  quite  enough  to  bring  the  two  sides 
of  the  Balance  Sheet  into  equilibrium.  This  interesting  point  deserves 
some  little  consideration.  We  will  find  it  helpful  to  look  more  closely 
into  the  nature  of  the  Proprietor’s  Capital  Investment. 

If  we  assume  that  Mr.  Brown’s  Balance  Sheet  on  i)age  27  was 
dated  January  1,  1919  and  that  the  transactions  on  page  29  occurred 
during  the  month  of  January,  it  will  follow  that  the  Trial  Balance  on 
page  33  and  the  statements  made  therefrom  would  be  dated  February 
1,  1919.  Now  looking  at  H.  K.  Brown’s  Capital  item  in  the  January 
1 and  the  February  1 Balance  Sheets  we  find  them  the  same  in  amount. 
It  would  seem  from  this  that  Mr.  Brown’s  interest  in  the  Assets  was 
no  more  now  than  a month  ago.  But  let  it  be  noted  that  the  Profit  and 
Loss  Statement  clearly  shows  the  business  has  earned  a profit  during 
the  month — which  is  to  S‘dy,  it  has  more  Assets  than  before.  To  whoDi 
would  the  increase  in  Assets  (i.  e.  the  Profit)  belong  if  not  to  the 
proprietor  whose  invested  capital  and  guiding  hand  has  made  the 
profit  possible?  No  one  has  a better  claim;  the  proprietor’s  invest- 
ment and  his  efforts  give  him  the  right  to  the  gains  arising  therefrom. 
Evidently  Mr.  Brown’s  claim  against  the  Assets  on  February  1 is 
more  than  the  $5900  capital  he  originally  put  into  the  business;  his 
claim  now  really  consists  of  his  Investment  plus  any  profits  gained 
bv  the  business. 


34 


This  reasoning  is  supported  by  the  figures.  There  are  $8,360 
in  Assets;  of  this  total  $2,000  ($1,700  pins  $300)  is  claimed  by  out- 
siders; the  remainder  $6,360  ($8,360  less  $2,000)  would  naturally  be 
claimed  by  the  proprietor  as  his  own.  In  other  words,  the  proprietor 
will  claim  whatever  Assets  are  not  necessary  to  protect  outsiders.  This 
remainder  of  Assets  has  a technical  term — Net  Worth.  The  net  worth 
of  this  business  on  February  1,  then,  is  $6,360.  Bnt  looking  back  to 
the  January  1 Balance  Sheet  it  is  found  that  the  corresponding  figure 
(Net  Worth,  or  Proprietor’s  Capital)  was  $5,900. 

It  is  calculated  that  a sale  of  the  business  on  January  1 would 
net  the  proprietor  $5,900,  and  that  a sale  on  February  1 would  net 
him  $6,360,  it  is  clear  that  changes  have  taken  place  during  the  month 
very  favorable  to  Mr.  Brown.  Since  he  has  not  put  in  any  more  of 
his  own  money  to  increase  his  net  worth,  it  follows  that  the  increase 
must  have  come  from  the  operations  of  buying  and  selling  merchan- 
dise. A glance  at  the  Profit  and  Loss  Statement  shows  this  to  be  the 
case.  The  Profit  there  calculated  is  $460;  the  increase  in  Net  Worth 
from  January  1 to  February  1 is  found  to  be  $460  ($6,360  on  February 
1 less  $5,900  on  January  1).  The  amounts  agree  and  the  statements 
agree. 

Some  important  points  by  way  of  summary  are  as  follows : 

1 —  The  Net  Worth  of  a business  is  the  difference  between  its 
Assets  and  its  Liabilities  to  outsiders. 

2 —  The  difference  between  the  Net  Worth  at  two  different  dates 
should  show  the  same  net  profit  or  loss  on  the  Profit  and  Loss 
Statement,  allowance  being  first  made  for  any  fresh  invest- 
ment of  capital  or  withdrawal  thereof. 

3 —  The  Capital  from  the  previous  Balance  Sheet  plus  the  net 
profit  (or  minus  the  loss)  from  the  present  Profit  and  Loss 
Statement  will  give  the  new  capital  (or  Net  Worth)  for  the 
present  Balance  Sheet. 

4 —  If  the  Profits  be  added  to  (or  losses  deducted  from)  the  previ- 
ous Capital  and  the  resulting  figure  shown  on  the  current  Bal- 
ance Sheet  the  latter  statement  will  balance. 

The  statements  presented  above  are  now  shown  again  and  brought 
into  agreement — tied  together,  in  a way,  by  having  the  net  Profit 
from  one  added  into  the  other. 


35 


BALANCE 

SHEET  AS 

OF  FEBRUARY  1,  1919 

Assets 

Cash 

$2,060 

Liabilities 

Debts  Payable 

-$1,700 

Debts  Receivable 

1,000 

Notes  Payable 

300 

Notes  Receivable 

700 

H.  K.  Brown,  Capital, 

Land  and  Buildings 

3,500 

January  1 _ $5,900 

Delivery  Equipment 

. _ 900 

Add  Profit  from  Profit 

Fixtures 

200 

& Loss  Stm.  _ 460 

Net  Worth,  Feb.  1 

6,360 

$8,380 

$8,360 

PROFIT  AND  LOSS  STATEMENT 
For  Month  of  January,  1919 


Sales  __$1,200 

Purchases  700 


Gross  Profit  500 

Expenses  40 


Net  Profit  carried  to  Balance  Sheet $ 460 

It  may  be  here  noted  that  as  a mark  of  completion  the  equal 
totals  of  the  Balance  Sheet  are  always  underlined  with  a double  ruling. 
Note  also  that  the  technically  complete  heading  for  the  Balance  Sheet 
includes  the  phrase  ‘‘as  of  February  1,  1919”  or  other  date,  and  that 
the  heading  of  the  Profit  and  Loss  Statement  always  shows  the  period 
covered,  as  “month  of  January,  1919,”  or  “year  ended  December  31, 
1919.” 

PROBLEMS— CHAPTER  IV. 

1.  Take  a Trial  Balance  of  the  Ledger  from  Problem  3,  Chapter 

III. 

2.  Turn  back  to  Chapter  II  for  the  several  illustrative  tran- 
sactions again.  Analyse  each  transaction  there  into  terms  of  Debits 
and  Credits  and  show  the  results  thus: 

Debit  the  Credit  the 

(1)  account  with  $xxx  account  with  $xxx 

(2)  account  with  $xxx  account  with  $xxx 

etc. 


36 


3.  From  the  following  Trial  Balance,  prepare  the  Balance  Sheet 
and  the  Statement  of  Profit  and  Loss. 

TRIAL  BALANCE 


Sales  

Notes  Receivable  

Notes  Payable 

John  McCrae,  Capital 
Furniture  and  Fixtures 

Debts  Receivable  

Cash 

Expense  

Debts  Payable 

Purchases  

Delivery  Equipment 
Land  and  Buildings  __ 
Repairs  


.$ 

$26,000 

. 1,200 

900 

12,000 

700 

. 4,400 

. 4,200 

. -1,800 

1,400 

. 18,000 

. 2,800 

. 7,000 

200 

$40,300 

$40,300 

V. 

THE  JOURNAL 

Personal  Accounts.  In  previous  discussions  mention  has  been 
made  of  Debts  Receivable  and  Debts  Payable.  We  are  now  to  observe 
that  these  two  accounts  do  not  provide  a sufficiently  detailed  record 
of  debts.  The  Proprietor  needs  to  know,  not  only  the  total  owing  to 
him  and  by  him,  but  the  amount  due  from  each  individual  customer 
and  due  to  each  individual  creditor  as  well.  Consequently,  it  falls  to 
accounting  to  provide  the  necessary  records. 

Instead  of  one  account  for  Debts  owing  to  us,  a considerable  space 
in  the  Ledger  is  usually  set  aside  and  accounts  opened  therein  for 
every  customer  who  buys  on  credit.  Another  portion  of  the  Ledger 
will  be  given  over  to  the  separate  accounts  of  the  people  we  owe.  These 
two  sections  of  the  Ledger,  then,  contain  the  accounts  of  debts  re- 
ceivable by  us  and  the  accounts  of  debts  payable  by  us.  In  other 
words,  the  Ledger  contains  a group  of  Accounts  Receivable  and  a 
group  of  Accounts  Payable: 

These  are  general  class  names  and  all  we  have  learned  in  the  past 
about  a Debt  Receivable  account  applies  with  equal  force  to  each  sepa- 
rate individual ’s  Account  Receivable.  Whenever  an  account  is  opened 
for  a customer,  that  account  is  an  Account  Receivable ; it  is,  therefore, 
an  Asset,  and  as  such  it  will  have  a debit  balance,  and  it  will  be  debited 
for  increasing  transactions  and  credited  for  decreasing  transactions. 

In  a similar  way  we  can  describe  Accounts  Payable.  Whenever 


37 


a ])urchase  is  made  on  credit  a debt  is  incurred ; in  order  properly  to 
record  it,  there  should  be  an  Account  Payable  opened  with  the  indi- 
vidual creditor  and  headed  with  his  name.  Such  an  account  will  repre- 
sent a Liability  and  as  such  will  show  a credit  balance  and  will  receive 
increasing*  transactions  on  the  credit  side  and  decreasing*  transactions 
on  the  debit  side. 

The  method  of  reasoning*  out  transactions  is  in  no  way  changed 
by  the  introduction  of  personal  accounts  or  the  new  titles  “Accounts 
Receivable”  and  “Accounts  Payable”.  In  analysing  a transaction 
we  still  ask  ourselves : Which  two  accounts  are  increased  or  decreased  ? 
If  we  see  that  a debt  is  contracted  or  discharged,  we  must  determine 
whether  it  is  Receivable  or  Payable.  Then  we  can  determine  whether 
the  person ’s  account  is  to  be  debited  or  credited,  for  we  know  the  plus 
and  minus  arrangement  of  all  accounts  including*  personal  Accounts 
Receivable  and  Accounts  Payable. 

A Book  of  Original  Entry.  Up  to  this  point  most  of  the  discus- 
sion has  had  to  do  with  statements  and  accounts.  We  have  seen  the 
statements  expanded  into  a book  (Ledger)  in  order  to  permit  the  many 
changes  to  the  items  to  be  easily  and  systematically  recorded,  and 
we  have  studied  the  classification  of  accounts  together  with  the  charac- 
teristics of  each  class.  As  a result  we  are  able  to  analyse  almost  any 
transaction  and  determine  what  accounts  are  involved,  whether  they 
are  increased  or  decreased,  whether  debited  or  credited.  We  have 
heretofore  made  the  entries  direct  to  the  proper  accounts  in  the  Led- 
ger, in  recording  the  results  of  our  analysis  of  transactions.  This  has 
been  done,  not  because  it  is  the  method  of  practical  business,  but  in 
order  to  confine  our  attentions  to  one  important  thing  at  a time. 

In  actual  business  no  entries  are  made  direct!}'  into  the  Ledger 
accounts ; there  is  always  a preliminary  record  standing*  between  the 
Ledger  and  the  Transaction ; no  transaction  can  reach  the  Ledger  ex- 
cept through  this  “Book  of  Original  Entry.”  There  are  two  reasons 
wliy  this  practice  has  grown  up  in  business.  The  first  is  the  need  for 
a record  of  transactions  in  date  order  which  can  be  made  as  they 
occur.  It  is  dangerous  to  wait  to  make  a record  of  facts;  one  may 
forget  to  make  any  record  at  all  or  may  omit  or  change  some  important 
]iarticular.  It  is  well,  too,  to  have  a chronological  record  so  that  the 
events  of  a particular  day  will  be  grouped  together  for  future  refer- 
ence. 

The  other  reason  lies  in  the  fact  that  experience  has  proved  the 


38 


Tisef Illness  of  having'  both  aspects  (debit  and  credit)  of  transaction  re- 
corded together.  Direct  entry  to  Ledger  accounts  causes  the  debit  of 
a given  transaction  to  be  widely  separated  from  the  corresponding 
credit,  which  is  entered  in  some  other  account.  No  one  can  refer  to 
the  records  and  understand  what  has  happened  if  only  one  side  of  the 
transaction  is  seen.  AVe  cannot  comprehend  the  full  meaning  of 
debit  and  credit  entries  unless  we  know  what  was  debited  at  the  same 
time  this  or  that  was  credited.  It  is  often  necessary  to  trace  the  entry 
from  the  Ledger  account  back  into  the  transaction  and  some  record 
is  necessary  to  connect  the  two,  some  record  showing  in  one  place 
both  the  debits  and  the  credits  for  the  given  occurrence.  The  first 
Book  of  Original  Entry  and  the  basis  of  all  others,  is  the  Journal.  The 
reasons  for  its  existence  have  been  examined  and  we  are  now  to  con- 
sider the  arrangement  of  the  entries  therein. 

It  has  been  observed  that  the  Journal  is  the  connecting  link  be- 
tween the  transaction  and  the  Ledger;  consequently  there  will  be  a 
great  deal  of  transferring  of  figures  from  Journal  to' Ledger,  (posting, 
it  is  called).  The  problem  of  getting  the  correct  entry  made  in  the 
Ledger  involves,  posting  to  the  proper  account,  posting  to  the  proper 
side  in  that  account,  and  writing  the  true  figure  and  no  other.  If 
the  Journal  Entry  is  to  be  well  constructed,  it  should  be  designed 
with  the  possibilities  of  error  in  mind  and  so  arranged  as  to  help  reduce 
mistakes  to  a minimum.  The  form  of  the  entry  is  as  follows : 

July  24— 

John  Brown 

Cash 

Paid  the  account  due  today  for  goods 
bought  July  8th 

Pcsting.  In  every  Journal  Entry  there  are  three  essential  parts, 
(I)  the  accounts  involved,  (2)  the  amounts  involved,  (3)  the  explana- 
tion. In  addition  to  this  there  usually  is  a date  in  the  middle  of  the 
line  above  the  entry. 

The  account  to  be  debited  is  always  named  first  and  is  written 
close  to  the  left  margin ; the  account  to  be  credited  is  always  named 
second  and  is  indented  a little  to  the  right.  This  arrangement  has 
the  effect  of  marking  out  the  debit  from  the  credit  to  even  the  most 
hurried  glance.  The  amount  to  be  debited  is  to  be  written  on  the  same 
line  as  the  account  name  and  in  the  first  column;  the  amount  to  be 
credited,  in  the  second  column.  Here  is  another  obvious  sign  of 
which  is  the  debit  and  which  the  credit.  Later,  we  shall  find  entries 


$400.00 


$400.00 


89 


containing’,  say,  one  debit  and  two  credits ; the  figures  might  be  posted 
to  the  wrong  side  of  the  account  unless  we  fix  in  mind  the  principle 
that  amounts  in  the  .first  column  of  the  Journal  are  posted  to  the 
debit  side  of  the  accounts  and  amounts  in  the  second  to  the  credit  side. 
The  whole  idea  of  the  form  of  the  Journal  Entry  is  to  make  posting 
easier  and  more  accurate  by  directing  the  eye  irresistibly  to  one  item 
as  the  debit  and  to  the  other  as  the  credit. 

The  Journal  Entry  may  be  said  to  be  the  record  of  the  conclusion 
reached  in  analysing  a transaction.  The  accounts  to  be  debited  and 
credited  are  determined  by  analysis  and  reasoning;  the  result  of  the 
thinking  is  made  note  of  by  constructing  the  Entry.  At  the  time  of 
posting,  it  is  not  necessary  to  reconsider  the  transaction ; judgment 
was  formed  before  the  Journal  Entry  was  made,  and  one  should  now 
transfer  to  the  Ledger  just  what  debits  and  credits  the  Journal  Entry 
states.  In  a word,  be  sure  when  making  the  Journal  Entry  that  it 
shows  exactly  what  you  want  to  bring  into  the  Ledger;  then  posting 
becomes  an  easy  mechanical  routine.  No  Journal  Entry  should  be 
constructed  without  a very  clear  idea  at  the  time  of  just  the  effect 
it  will  have  upon  the  accounts  when  posted. 

Errors.  Since  many  mistakes  occur  in  reading  and  writing  fig- 
ures, care  must  be  taken  to  make  figures  plain  and  unmistagable  in  the 
first  place  and  then  to  read  them  with  mind  alert  when  they  are  l-.o 
be  posted  and  rewritten.  Some  people  have  developed  a habit  of 
forming  a “picture’’  of  the  figures  read  and  then  writing  them  down 
as  they  looked  to  the  eye.  This  often  leads  to  mistakes.  The  proper 
way  is  to  read  the  figures  so  the  mental  impression  is  that  of  figures 
spoken  rather  than  seen ; then  while  writing  them  in  the  Ledger  the 
mental  image  should  again  be  that  of  spoken  figures.  Before  leaving 
the  particular  entry  it  should  be  checked  back  by  glancing  at  the 
original  amount  again.  The  mental  point  of  view  can  easily  be  changed 
now  and  the  amounts  compared  as  purely  visual  images.  The  same 
principle  of  altering  the  mental  sequence  is  followed  in  checking  addi- 
tion for  errors.  If  the  habitual  practice  is  to  add  the  column  down- 
ward, reverse  and  add  upward  when  checking.  The  habit  should  also 
be  developed  of  always  writing  the  Ledger  page  opposite  the  posted 
item  in  the  Journal  IMMEDIATELY  upon  posting.  Any  entries, 
then,  without  the  posting  page  suggest  an  error  because  of  an  omitted 
posting. 


40 


VL 


SPECIAL  BOOKS  OF  ORIGINAL  ENTRY 

All  transactions  can  be  Journalized  and  posted  from  the  Journal, 
but,  it  should  be  observed,  the  physical  limitation  of  a single  Book  of 
Original  Entry  would  seriously  handicap  the  larger  businesses  of  today. 
There  are  too  many  transactions  to  be  contained  in  one  Journal;  there 
are  many  more  entries  to  make  than  one  man  could  possibly  take  care 
of  alone.  Modern  business  has  been  forced  to  abandon  the  practice  of 
entering  ever}'  transaction  through  the  Journal.  The  development 
which  has  taken  place  has  been  in  the  direction  of  subdividing  the 
general  purpose  Journal  into  several  special  purpose  Journals. 

Specialized  Journals.  If  the  problems  should  be  presented  of 
choosing  those  entries  which  should  hereafter  be  written  in  a separate 
book,  one  would  naturally  seek  first  to  eliminate  from  the  Journal  those 
most  frequently  repeated.  No  doubt  Sales  entries  and  Purchase 
entries  would  first  attract  attention  by  their  number. 

Should  the  plan  be  adapted,  a separate  Sales  Journal  to  receive 
only  entries  for  sales  on  account  would  perhaps  provide  work  for  one 
man;  another  book,  a Purchase  Journal  to  receive  entries  only  for 
Purchases  on  credit,  would  occupy  a second ; a third  might  have  charge 
of  the  general  Journal  for  all  other  entries.  Thus  at  least  three  times 
as  much  accounting  work  could  be  done  as  would  be  possible  with 
only  one  Journal  and  one  bookkeeper. 

No  doubt  the  next  class  of  entries  found  numerous  enough  to 
warrant  a separate  Journal  would  be  Cash  Receipts.  These  put  in 
charge  of  another  clerk  would  mean  further  subdivision  of  labor  and 
more  work  done.  The  process  of  subdivision  would  likely  be  carried 
a step  further  and  the  Cash  Payments  set  up  in  a separate  Journal. 
Quite  possibly  this  record  would  be  in  charge  of  the  same  person  hav- 
ing the  Cash  Receipts  to  care  for ; handling  all  the  cash — receipts  and 
payments — he  would  be  called  the  Cashier. 

The  ordinary  special  Journals,  then,  may  be : 

1 — Purchase  Journal — containing — 

Debits  to  Purchases  Account, 

Credits  to  various  Creditors’  accounts. 


41 


2 —  Sales  Journal — containing — 

Debits  to  various  Customers’  accounts. 

Credits  to  Sales  Account. 

3 —  Cash  Received  Journal — containing — 

Debits  to  Cash  Account, 

Credits  to  various  accounts. 

4 —  Cash  Paid  Journal— containing — 

Debits  to  various  accounts, 

Credits  to  Cash  Account. 

The  subdivision  of  the  Journal,  it  should  be  noted,  does  not  alter 
in  any  way  the  analysis  of  transactions  and  their  expression  in  terms 
of  Debit  and  Credit.  The  Ledger  accounts  are  altogether  unchanged ; 
only  the  posting  is  changed,  and  that  simply  to  the  extent  of  there 
being  several  sources  of  posting  instead  of  one. 

Total  Posting.  The  subdivision  of  the  single  Journal  as  above 
described  is  more  expressive  of  the  idea  underlaying  Special  Books 
of  Original  Entry  than  it  is  of  the  form  Sales  Books,  Cash  Books,  etc. 
take  in  actual  practice.  Although  all  Books  of  Original  Entry,  what- 
ever their  form,  continue  to  express  both  Debits  and  Credits,  it  is 
not  necessary  in  modern  practice  carefully  to  name  both  accounts  in 
order  to  do  so.  A moment’s  consideration  of  the  Special  Journals 
will  make  this  plain. 

In  the  Sales  Journal,  every  credit  entry  will  be  a credit  to  Sales 
Account.  What  would  be  simpler  than  to  find  the  total  of  all  the 
entries  for  a month  and  post  that  one  sum  to  the  credit  of  Sales 
Account  instead  of  posting 'twenty  or  forty  (or  two  hundred)  sepa- 
rate amounts?  Estimate  the  lessened  chance  of  mistakes  and  the 
saving  in  time  in  posting  one  figure  compared  with  forty.  Consider 
the  saving  of  time  in  writing  only  half  as  much  in  recording  an  entry. 
In  a Sales  Journal  several  entries  would  take  this  form: 


SALES  JOURNAL 


John  Jones 

Sales  - . 

$600 

$600 

H.  K.  Potts 

Sales 

700 

700 

P.  D.  Downs 

Sales 

_ 400 

400 

Etc.,  etc. — 

But  since  every  Credit  is  to  be  to  Sales  Account  finally  and  since 
the  Debit  figures  are  the  same  amount  as  the  Credit  in  each  entry,  we 
accomplish  as  much  with  modern  Sales  Book  as  we  could  Avith  a Sales 


42 


Journal,  by  writing  the  debit  portion  only  and  obtaining  the  credit  by 
adding  the  debits.  Thus  the  Sales  Book  would  be  as  follows : 

SALES  BOOK 


John  Jones  $ 600 

H.  K.  Potts 700 

P.  D.  Downs ^ 400 


Total  Sales  (Cr.) $1,700 


In  posting  the  above,  the  three  items  would  go  simply  to  the 
debit  of  the  Personal  accounts  named  one  by  one  and  at  the  end  of 
the  month,  these  three  Debits  would  be  equalized  in  the  Ledger  by  the 
corresponding  Credit  of  $1700.  Thus  the  Trial  Balance  would  not 
be  disturbed  by  any  inequality  of  Debits  and  Credits. 

What  has  been  said  in  detail  about  the  Sales  Book  could  be  said 
about  each  of  the  others ; the  plan  that  would  secure  economy  of  time 
and  increased  accuracy  in  one  would  apply  equally  well  to  the  others. 
So  we  would  find  the  Purchase  Book  producing  a total  to  be  debited 
to  Purchases  Account ; Cash  Received  a total  to  be  debited  to  Cash 
Account ; Cash  Paid,  a total  to  be  credited  to  Cash  Account. 

The  close  relation  of  the  Cash  Received  Book  and  Cash  Paid  Book, 
and  the  fact  that  both  have  to  be  used  in  finding  the  balance  of  Cash 
on  hand  at  any  time,  leads  to  the  practice  of  having  them  bound 
together,  or,  what  amounts  to  the  same  thing,  using  only  one  volume 
but  writing  Cash  Received  entries  on  the  left  hand  page  and  Casli 
Paid  entries  on  the  right  hand  page.  This  is  a very  convenient  ar- 
rangement and  does  not  disturb  in  the  least  the  postings  as  already 
described;  the  same  accounts  are  Debited  and  Credited  in  detail  and 
total  from  the  one  volume  Cash  Book,  as 'from  two  separate  Cash 
Books. 

Later  on  we  shall  see  the  form  of  the  Cash  Book  modified  by  the 
introduction  of  a number  of  extra  money  columns  for  the  further 
segregation  of  like  entries.  At  that  time  it  will  be  pointed  out  in 
more  detail  that  such  an  arrangement  permits  the  accumulation  ot 
totals  so  that  the  quantity  of  posting  is  again  reduced  just  as  it  is 
where  Special  Books  of  Original  Entry  replace  a single  Journal. 


43 


A^Il. 


DIRECT  CLOSING 

Purpose  of  Closing.  In  Chapter  IV  it  was  pointed  out  that  the 
profit  earned  by  a business  belonged  to  the  Proprietor.  It  was  also 
shown  how  the  Net  Profit  on  the  Profit  and  Loss  Statement  must  be 
brought  into  the  Balance  Sheet  as  an  addition  to  the  Proprietor’s 
previous  investment  in  order  to  cause  the  Balance  Sheet  to  exhibit 
the  true  state  of  affairs  at  that  particular  time. 

If  the  real  fact  is  that  the  Proprietor’s  interest  in  the  busniess 
on  February  1 is  more  than  the  Ledger  account  for  Capital  Invest- 
ment shows,  it  must  follow  that  the  account  should  be  adjusted  so  it, 
as  well  as  the  Balance  Sheet,  may  state  the  whole  truth  about  Capital 
Investment.  This  can  only  mean  that  the  Proprietor’s  Account  in 
the  Ledger  must  be  increased  by  the  amount  of  the  profit  made.  Since 
the  profit  is  determined  by  the  amount  of  the  Sales,  Purchases  and 
Expenses,  these  are  the  accounts  which  must  be  brought  into  relation- 
ship with  the  Proprietor’s  Account  in  order  to  increase  it  by  the 
amount  of  Net  Profit. 

Direct  Closing.  In  order  to  see  these  nominal  accounts  trans- 
ferred to  the  Capital  Account,  , it  is  necessary  to  look  at  the  Ledger  as 
it  now  stands  and  then  to  trace  step  by  step  the  changes  produced  by 
the  desire  to  assemble  these  several  accounts  in  one  place.  The  accounts 
we  are  interested  in  just  now  are  as  follows : 


Purchases  Sales 


plus 

minus 

minus 

plus 

$700 

$1,200 

Expense 

H.  K.  B. 

Capital  Invested 

plus 

minus 

minus 

plus 

$40 

$5,900 

(The  student  should  take  a copy  of  these  accounts  on  scratch  paper  and 
make  the  changes  therein  one  by  one  as  they  are  discussed  in  the  text.) 


44 


Recall  that  Purchases  were  described  as  Recoverable  Outlays — 

i.  e.  funds  were  advanced  out  of  the  Proprietor’s  Capital  and  were 
to  be  replaced  when  the  goods  were  sold. 

METHOD  L 

1.  Bring  the  $700  Purchases  to  the  minus  (Debit)  side  of  Capi- 
tal Account  and  it  appears  that  Capital  is  temporarily  reduced.  With 
the  $700  now  in  Capital  Account  the  Purchase  Account  is  no  longer 
useful;  it  should  be  brought  to  a “zero”  condition  by  an  entry  of  $700 
on  the  minus  side.  Here,  then,  is  expressed  a decrease  to  Purchases 
Account  and  a decrease  to  Capital ; the  $700  value  has  been  removed  or 
subtracted  from  the  former  account  and  placed  in  the  latter.  (Note 
the  peculiar  way  accounting  expresses  a subtraction  within  accounts  by 
effecting  a cancellation  of  an  item  by  an  equal  entry  on  the  opposing 
side  of  the  same  account.) 

2.  Bring  the  $40  from  Expense  Account  to  the  Capital  Account 
in  the  same  manner.  This  second  step  has  the  effect  of  transferring 
this  other  Recoverable  Outlay  also  to  the  Capital  Account.  Now  the 
Proprietor’s  Capital  seems  materially  reduced  by  these  entries,  but 
we  know  the  outlays  were  only  temporarily  advanced  and  that  the 
Proprietor  got  his  money  back  again  almost  at  once.  During  the 
month  as  Sales  were  made  and  part  of  the  costs  and  expenses  recovered, 
the  amounts  were  assembled  in  the  Sales  Account.  Now  at  the  end 
of  the  period  it  is  desired  to  bring  these  Recovered  amounts  into  close 
comparison  with  the  amounts  advanced  to  see  what  the  net  effect  upon 
the  Proprietor’s  interest  in  the  business  has  been. 

3.  Bring  the  $1,200  Sales  into  the  Capital  Account  as  an  increase, 
thus  setting  it  up  in  opposition  to  the  costs  already  on  the  decrease 
side.  Show  the  $1,200  eliminated  from  the  temporary  Sales  Account 
by  placing  another  $1,200  on  the  decrease  side. 

4.  Whenever  the  two  opposing  sides  of  an  account  are  equal 
(in  balance,  as  we  say),  indicate  the  fact  by  ruling  a double  horizontal 
line  across  the  account  close  up  under  the  figures.  This  has  the  effect 
of  shutting  off  the  figures  above  the  line  so  they  will  not  be  added  in 
with  any  new  figures  for  succeding  periods  which  may  be  posted  to 
the  account  below  the  ruling. 

5.  As  a last  step  bring  the  Capital  Account  to  a balance,  rule  it 
up  and  bring  the  balance  forward  into  the  new  period  as  in  the 
illustration  on  the  next  page. 


45 


Tlie  Ledger  now  stands  as  follows : 

Purchases  Sales 


plus 

$700 


minus 

$700 


minus 

plus 

$1,200 

$1,200 

' 

Expenses 


Capital 


plus 

$40 


minus 

$40 


minus 

plus 

Purchases,  $700 

Original 

$5,900 

Expenses,  40 

Balance,  new 
Capital,  6,360 

Sales 

1,200 

$7,100 

$7,100 

Present 

Invest- 

ment 

-$6,360 

METHOD  II 

Another  method  of  closing  these  nominal  accounts  and  transfer- 
ing  their  balances  into  the  Capital  Account  is  to  proceed  through  an 
intermediate  summary  account.  For,  it  will  be  observed,  the  above 
Capital  Account  does  not  clearly  show  what  the  net  increase  to  Capi- 
tal is  (i.  e.  the  amount  of  the  Net  Profit).  It  is  desirable  to  show  this 
in  the  Ledger  as  one  amount,  and  it  is  also  desirable  to  avoid  bring- 
ing many  accounts  (as  in  a large  business)  directly  into  the  Capital 
Account.  For  these  reasons  a Profit  and  Loss  Account  is  introduced 
to  provide  a convenient  place  of  summarizing  the  nominal  accounts 
and  calculating  the  net  profit  to  be  carried  as  one  figure  to  the  Capi- 
tal Account. 

1.  Open  an  account  headed  '‘Profit  and  Loss.” 

2.  Transfer  the  $700  from  Purchases  Account  to  the  Profit  and 
Loss  Account  (Note  this  principle:  the  amount  transferred  from  any 
account  whatever  must  appear  in  the  new  account  on  the  same  side. 
Debit  or  Credit,  as  the  original  amount  stood  in  the  original  account). 
Profit  and  Loss  is  debited  $700;  Purchases  is  credited.  The  original 
debit  in  Purchases  Account  (cancelled  by  the  new  opposing  entry) 
is  now  transferred  to  be  a debit  in  the  Profit  and  Loss  Account — once 
a debit  always  a debit. 

3.  Transfer  in  like  manner  the  debit  from  Expense  Account. 

4.  Transfer  in  like  manner  the  credit  from  Sales  Account. 


46 


It  will  now  appear  that  the  nominal  accounts  are  closed  (ruled) 
off  and  their  values  summarized  in  the  Profit  and  Loss  Account.  The 
credit  side  (sales  or  gains)  is  seen  to  be  larger  than  the  debit  (costs)  ; 
the  conclusion  is  that  a net  profit  has  been  made.  The  excess  of 
credits  over  debits  in  this  account  (i.  e.  the  credit  balance)  is  the 
amount  of  net  profit  to  be  added  to  the  Capital  Account. 

5.  Transfer  the  Balance  of  the  Profit  and  Loss  Account  to  the 
Capital  Account.  Since  the  Profit  and  Loss  credits  are  more  than  the 
debits,  it  will  be  necessary  to  introduce  another  debit  to  eliminate  the 
balance  and  close  off  the  account.  Since  Net  Profit  naturally  increases 
Capital  Account,  there  must  be  a credit  to  that  account  of  the  same 
amount,  debited  to  Profit  and  Loss  to  bring  it  (Profit  and  Loss  Ac- 
count) to  a close. 

6.  Calculate  the  Present  investment  (Previous  Investment  plus 
Net  Profits)  ; close  the  Capital  Account  and  bring  the  Present  Invest- 
ment forward  as  before. 

The  accounts  in  the  illustration  which  will  be  different  under  this 
method  are  as  follows : 


Profit  and  Loss 


Capital 


Purchases,  $700 
Expenses,  40 

Balance,  Net 
Profit,  trans- 
ferred to 
Capital,  460 


$1,200 


Sales  $1,200 


$1,200 


Present 

Worth,  $6,360 


Original  $5,900 
Net  Profit 
from  P/L 
a/c  460 


Present 

Worth,  $6,360 


Inventories.  In  the  discussions  up  to  tliis  point  it  lias  been  as- 
sumed for  the  sake  of  simplicity  that  all  of  the  merchandise  purchased 
was  sold  in  the  same  period.  This,  of  course,  does  not  accord  with 
actual  business,  for  generally  some  of  last  month’s  purchases  have  to 
be  carried  over  into  the  next  month  or  longer  and  are  sold  in  some 
subsequent  period.  The  fact  that  some  goods  have  to  be  carried  over 
unsold  makes  a great  deal  of  difference  in  the  profits  of  a given  period. 

No  one  can  claim  a profit  until  the  ownership  of  the  goods  passes 
to  another,  so  the  method  of  calculating  profits  must  be  revised.  Where 
all  goods  are  sold  in  the  same  period  as  they  are  bought  we  may  say 
that  Sales  less  Purchases  equals  gross  profits.  But  if  some  of  the 
Purchases  are  unsold,  we  must  say  Sales  less  Cost  of  Goods  Sold  equals 
Gross  Profit  (i.  e.  the  profit  before  deducting  Expenses).  Therefore 


47 


before  finding  Gross  Profit  it  is  necessary  to  make  another  calculation 
to  find  the  'Cost  of  Goods  Sold. 

Suppose  in  a given  period  we  bought  $8,000  worth  of  goods  and 
at  the  end  of  the  period  found  by  actual  count  (i.  e.  by  taking  inven- 
tory) that  $2,000  of  the  purchases  were  still  on  hand.  The  conclu- 
sion would  naturally  follow  that  $6,000  ($8,000  less  $2,000)  was  the 
purchase  cost  of  the  goods  sold.  Then,  if  in  the  same  period 
the  sales  amounted  to  $10,000,  the  Gross  Profit  would  be  $4,000 
($10,000  less  $6,000). 

If  an  Inventory  of  unsold  goods  exists  at  the  time  of  summariz- 
ing and  closing  the  nominal  accounts,  it  must  be  considered  as 
the  very  first  step  of  the  process.  Before  transferring  the  balance  of 
Purchases  Account  to  the  Profit  and  Loss  Account,  the  Inventory  must 
be  eliminated  from  the  former  so  that  the  amount  to  be  transferred 
will  be  the  cost  of  goods  sold.  If  the  Inventory  be  taken  out  of  Pur- 
chases Account,  it  must  be  set  up  somewhere  else  for  one  cannot  bodih" 
abstract  a portion  of  the  amount  in  an  account  without  disturbing 
the  equality  of  total  debits  and  credits  in  the  Ledger. 

Since  the  Inventory  is  an  amount  of  goods  on  hand,  it  takes  on 
for  the  moment  the  characteristic  of  an  asset.  It  will  appear  in  the 
Balance  Sheet  as  such  and  should  stand  in  the  Ledger  in  a separate 
account.  The  procedure  under  these  conditions  will  be  as  follows : 

1.  Transfer  the  value  of  the  Inventory  (taken  at  cost  prices) 
out  of  the  Purchases  Account  into  an  “Inventory  Account”.  This 
necessitates  a credit  (minus)  to  Purchases  and  a debit  (as  a plus  to  an 
asset)  in  Inventory  Account.  The  balance  then  remaining  in  Pur- 
chases represents  the  cost  of  that  portion  of  the  purchases  which  was 
sold. 

2.  Transfer  the  balance  of  Purchases  account  (i.  e.  cost  of  goods 
sold)  to  the  debit  side  of  Profit  and  Loss. 

The  other  steps  in  the  closing  process  are  identical  with  those  al- 
ready outlined. 

Old  and  New  Inventories.  If  we  are  working  in  any  but  the  first 
month  of  a firm’s  existence,  we  will  see  that  there  is  not  only  an  Inven- 
tory of  goods  unsold  at  the  end  of  that  particular  period  but  that  there 
is  also  an  Inventory  of  goods  on  hand  at  the  beginning  of  the  month. 
There  is  an  old  and  a new  Inventory ; next  month  the  present  new 
Inventory  becomes  the  old  one. 

In  order  to  calculate  the  Gross  Profit,  it  is  still  necessary  first  to 


48 


find  the  cost  of  goods  sold  in  the  given  period ; usually  this  calculation 
involves  two  Inventories,  The  goods  we  dispose  of  this  month  may 
have  been  bought  this  month  or  last  month ; they  may  have  been  sold 
from  the  old  Inventory  or  from  current  purchases. 

Suppose  we  sold  all  we  had;  then  the  cost  of  goods  sold  would 
be  the  old  Inventory  plus  the  purchase  of  this  current  month,  and  that 
figure  from  the  Sales  would  give  the  Gross  Profit.  But  that  condition 
prevails  only  in  the  last  month  of  a firm’s  existence;  the  ordinary 
month  will  have  a new  Inventory  at  the  end  to  be  subtracted.  Using 
some  hj'pothetical  figures,  the  calculation  of  an  ordinary  month’s  gross 
profit  would  be  as  follows : 


Sales  during  the  month  $20,00u 

Old  Inventory  at  beginning  of  month $ 8,000 

»dd,  Purchases  during  the  month 14,000 


$22,000 

Deduct  New  Inventory  at  end  of  month 9,000 

Cost  of  Goods  Sold 13,000 


Gross  Profit $ 7,000 


(Let  it  be  noted  that  this  shows  the  arrangement  of  a section  of 
the  Profit  and  Loss  Statement.) 

We  have  to  note  how  these  additions  and  subtractions  are  secured 
in  the  Ledger  and  how  the  result  of  the  adjustment  of  the  accounts 
is  the  calculation  of  the  Profit  directly  in  the  Ledger  accounts. 

The  student  should  copy  these  accounts  as  before  and  make  the 
adjustments  as  they  are  described.  The  accounts  as  they  stand  at 
the  close  of  last  month  would  be  as  follows : 


Inventory  Purchases 


$8,000 

$15,000 

to  Inv, 

$8,000 

! 

to  P/L  a/c 

7,000 

Sales  Profit  and  Loss 


to  P/L  a/c  $17,000 

$17,000 

1 

Cost  $ 7,000 

To  Can  a/c  10  000' 

Sales 

$17,000 

X V/  • CL / \j  XV/>W\/| 



1 

• 1 

49 


All  of  the  accounts  we  need  to  consider  here  will  be  seen  to  be 
blank  except  Inventory  for,  being  ruled  at  the  end  of  last  month,  they 
are  to  all  intents  and  purposes,  void  of  figures  now. 

Assume  the  Purchases  of  this  current  month  to  have  been  $14,000 
and  the  Sales  $20,000.  Enter  the  amounts  in  the  accounts  as  if  they 
had  been  posted  there.  We  are  now  ready  to  close. 

1.  Transfer  the  old  Inventory  ($8,000)  back  to  the  Purchases 
Account.  It  will  now  appear  cancelled  out  of  the  Inventory  Account 
and  set  up  as  a debit  to  the  Purchases  Account  to  be  added  in  with 
the  goods  purchased  during  this  month.  The  debit  side  of  the  Pur- 
chases Account  now  shows  the  total  cost  of  all  goods  offered  for  sale 
regardless  of  when  purchased. 

2.  The  new  Inventory  is  found  by  actual  count  of  the  articles 
on  the  shelves  to  be  $9,000.  Transfer  this  Inventory  out  of  the  Pur- 
chases Account  into  the  Inventory  Account  by  crediting  Purchases 
and  debiting  Inventory.  The  balance  remaining  in  the  Purchases  Ac- 
count now  shows  the  true  cost  of  goods  sold.  (Compare  with  the  sec- 
tion of  the  Profit  and  Loss  Statement  above). 

3.  Transfer  this  cost  of  goods  sold  to  the  Profit  and  Loss  Account ; 
transfer  Sales  and  Expenses,  and  proceed  from  this  point  as  previ- 
ously instructed. 

The  accounts  as  readjusted  in  closing  as  above  outlined  for  two 
Inventories,  are  as  follows,  the  values  for  the  second  period  being  in 
italics : 


Inventory 


From  Pur-  | Return  to 

chases  a/c  $8,000  j Purchas- 

j es  a/c  $8,000 


From  Pu7'- 
cfiases  a/c  9,000 


Purchases 


Bought 

$15,000 

To  Inven- 
1 tory  a/c  $ 8,000 
! To  P & L 

a/c  7,000 

From  In- 

To lnve7i- 

ventory 

t07'y  a/c  $9,000 

a/c 

$ 8,000  1 

To  P d L 

Bought 

lJt,000 

a/c  13,000 

Expense 


Sales 


Cost  $1,200  I To  P & L 

a/c  $1,200 


To’P  & L 
a/c  $17,000 


Sold 


$17,000 


1,800 


To  P d-  L 

a/c  1,800 


To  P d L 
a/c  $20,000 


$20,000 


Cost 


50 


Sold 


Profit  and  Loss 


Prom  Purchases  a/c  $ 7,000 

Balance  Gross  Profit  10,000 

From  Expense  a/c  1,200 

Net  Profit,  to  Capital  a/c  8,800 


From  Purchases  a/c  13,000 

Balance,  Gross  Profit  1,000 

From  Expense  a/c  1,800 

Net  Profit,  to  Capital  a/c  5,200 


From  Sales  a/c 

$17,000 

— 

Gross  Profit  down 

10,000 

From  Sales  a/c 

20,000 

Gross  Profit  down 

7,000 

Capital 


Balance  forward 

$33,800 

Original  Investment 
From  P & L a/c 

$25,000 

8,800 

33,800 

33,800 

Balance  forward 

39,000 

Present  Capital 

From  P d-  L a/c 

33,800 

5,200 

39,000 

39,000 

Present  Capital 

39,000 

PROBLEMS— CHAPTER  VII 

1.  Below  are  tabulated  the  essential  facts  about  the  nominal 
accounts  of  a business  for  six  successive  periods.  First,  on  Ledger 
paper  open  the  necessary  accounts,  then,  second,  one  month  at  a time, 
place  the  Purchases,  Sales  and  Expenses  values  in  the  accounts  as 
if  posting,  and  then,  third,  close  the  accounts  for  the  month.  Proceed 
in  like  manner  for  the  second  month,  then  the  third,  and  so  on. 

What  was  the  present  capital  at  the  end  of  the  six  months,  if  the 
original  Investment  was  $10,000  ? 


Month 

Beginning  Closing 
Invty.  Invty. 

Month’s 

Purchases 

Month’s 

Sales 

Month’s 

Expense 

Jan. 

. $5,000 

$9,645 

$ 8,296 

$14,642 

$ 900 

Feb. 

_ . 9,645 

8,471 

11,318 

12,978 

1,200 

Mar. 

8,741 

6,272 

16,684 

16,491 

1,687 

Apr. 

. 6,272 

7,448 

13,841 

18,296 

1,407 

May 

. 7,448 

8,197 

10,162 

21,824 

1,007 

June 

8,197 

9,121 

8,973 

19,170 

1,333 

51 


YIIT. 


JOURNAL  (J.OSING 

The  previous  discussion  of  closing*  does  not  pretend  to  portray 
the  procedure  found  in  practice.  It  has  alread}^  been  pointed  out 
that  no  entries  are  made  directly  in  the  Ledger  and  closing  entries 
are  no  exception.  But  it  should  be  remembered  that  Journal  Entries 
of  any  kind  express  debits  and  credits  and  that  debits  and  credits 
can  be  determined  only  with  respect  to  accounts.  Therefore,  no  matter 
what  the  entry,  it  is  constructed  with  the  Ledger  accounts  in  mind. 
When  we  have  decided  what  change  has  occurred  to  the  accounts  it 
is  an  easy  matter  to  construct  a Journal  Entry  to  record  our  decision. 
But  the  accounts  have  to  be  thought  out  first;  the  Journal  Entry  only 
records  our  judgment. 

So  the  discussion  of  closing  the  nominal  accounts  directly  in  the 
Ledger  has  shown  the  way  the  steps  must  be  thought  out.  Now  to 
get  those  changes  made  in  the  accounts  according  to  the  very  strict 
accounting  procedure,  they  must  be  entered  in  a book  of  original  entry 
and  posted. 

The  form  of  ordinary  Journal  Entry  is  already  in  mind;  we 
have  but  to  decide  the  debits  and  credits  for  each  step,  arrange  them 
in  the  customary  way  and  post.  Using  the  example  on  page  50  and 
51  the  several  steps  would  become  Journal  Entries  as  follows; 


1 —  Purchases  $ 8,000 

Inventory  

to  transfer  last  months’  inventory  to 
Purchases  Account 

2 —  Inventory  9,000 

Purchases  

to  transfer  the  present  inventory  out  of 
Purchases  Acct.  into  an  account  of  its  own. 

3 —  Profit  and  Loss 13,000 

Purchases 

to  transfer  the  cost  of  goods  sold  (bal- 
ance of  Purchases  Account)  to  the  Profit 
and  Loss  Account. 

4—  Sales 20,000 

Profit  and  Loss 

to  transfer  the  balance  of  Sales  Account 
to  Profit  and  Loss 


$ 8,000 


9,000 


13,000 


20,000 


52 


900 


900 


5 


6 


It  must  be  clearly  understood  that  these  entries  should  not  all 
be  made  at  once.  We  can  not  make  entry  3 for  example,  before  entries 
1 and  2 have  been  made  and  posted,  for  those  net  values  have  to  be 
used  in  calculating-  the  $13,000  for  entry  3.  Hence  the  following 
suggestions : 

1.  Reason  out  the  debit  and  credit  you  want  brought  into  the 
accounts  as  the  first  step  in  the  series. 

2.  Make  a Journal  Entry  for  them. 

3.  Post  this  first  entry  before  constructing  the  next. 

4.  Reason  out  the  next  step  of  summarizing  the  nominal  accounts, 
using  when  necessary,  the  adjusted  values  in  the  accounts  which  were 
changed  by  the  preceding  entry  or  entries. 

And  so  on,  step  by  step  through  the  whole  series  until  all  nominal 
accounts  are  closed  and  their  contents  summarized  in  the  Profit  and 
Loss  Account  and  it  closed  to  the  Capital  Account. 

PROBLEMS— CHAPTER  VIII. 

1.  Construct  closing  Journal  Entries’ for  the  problem  at  the  end 
of  Chapter  VII.  and  post  them  to  memorandum  Ledger  accounts  as 
you  go  along.  This  concurrent  posting  is  necessary  because  some  of 
the  values  to  be  used  in  the  closing  entries  are  the  balances  of  these 
accounts. 


— Profit  and  Loss 

Expense 

to  transfer  Expense  into  Profit  and  Loss. 

— Profit  and  Loss 6,100 

Capital  Investment 6,100 

to  transfer  the  net  profit  (balance  of 
Profit  and  Loss  Account)  to  Capital. 


53 


IX. 


MONTHLY  ADJUSTMENTS 

It  is  one  of  the  outstanding  principles  of  accounting  that  profit 
is  earned  when  the  service  is  rendered  for  which  the  profit  is  a pay- 
ment, rather  than  when  the  cash  is  received.  This  principle  arises  in 
our  understanding  of  jirofit  as  the  gain  coming  to  the  business  man  as 
Ids  compensation  for  the  service  he  performs  in  making  or  supplying 
tlie  goods. 

Deferred  Income.  We  know  that  the  sales  price  is  part  “costs 
returned”  and  part  profit  and  that  Sales  Account,  containing  the 
profit  element,  is  closed  into  the  Profit  and  Loss  Account  there  to 
offset  other  accounts  (Costs  and  Expenses)  which  are  also  closed  into 
it  in  finding  the  net  profit  of  the  period.  We  know  that  closing  the 
Sales  Account,  and  ruling  it,  forever  eliminates  those  sales  from  in- 
clusion in  any  future  period’s  calculation  of  net  profit,  and  we  know 
also  that  sales  made  on  credit  during  the  month  must  be  brought  into 
this  month’s  sales  account  before  it  is  closed;  this  is  but  putting  into 
practice  the  great  principle  stated  above  with  respect  to  profits  earned 
in  one  month  but  not  received  in  cash  until  some  subsequent  month. 
Would  it  not  be  logical  to  arrange  some  way  also  for  showing  profit 
received  in  advance  to  be  an  earning  of  the  later  period  when  the 
service  was  given? 

When  we  sell  goods  on  account  for,  say,  $800,  the  credit  to  Sales 
represents  an  earning  of  this  period;  the  debit  to  Accounts  Receiv- 
able represents,  in  a way,  a “deferred  cash  collection.”  When  wo 
receive  money  for  a sale  in  advance  of  the  actual  transfer  of  the  things 
sold  or  in  advance  of  actually  performing  all  of  the  services  agreed 
upon,  then  we  debit  Cash  to  record  the  increase  in  our  balance  on 
hand  and  the  credit  we  place  in  a Deferred  Income  Account.  This 
is  not  closed  like  a Sales  Account  into  Profit  and  Loss  for,  be  it  noted, 
it  does  not  contain  Profits  (or  Earnings)  of  this  month;  we  have  not 
earned  our  compensation  for  we  have  not  yet  done  our  part.  We  must 
see  in  the  Deferred  Income  Account  something  of  a Liability,  for  it 
represents  an  obligation  to  perform  a service  which  we  are  bound  to 
carry  out  because  of  having  already  been  paid  for  it. 


54 


As  examples  of  Deferred  Income  we  can  refer  to  the  Members 
dues  of  a clnb  or  society.  Say  the  dues  are  $60  a year;  being  paid 
at  one  time,  it  gives  the  member  all  privileges  for  twelve  months.  If 
accurate  accounting  is  to  be  had  by  the  club  of  the  costs  each  month 
and  the  income  available  each  month  to  defray  those  costs,  provision 
must  be  made  for  distributing  $5  of  the  $60  to  the  Profit  and  Loss 
Account  for  each  month. 


Dues  Account  (or  Deferred  Income  Acct.) $5 

Profit  and  Loss  Account $5 


to  transfer  1/12  of  the  year’s  earnings  into  the  Profit 
and  Loss  Account  for  the  current  month. 

This  entry  would  accomplish  the  result  desired.  $5  would  be 
taken  from  the  Deferred  Income  Account  by  the  debit  (decreasing) 
entry  and  added  to  the  Profit  and  Loss  Account  by  the  credit  entry. 
There  would  remain  a balance  of  $55  in  the  Deferred  Income  Account 
to  evidence  the  Liabilities  for  service  still  to  be  performed.  Other 
examples  of  deferred  income  are  not  hard  to  find  in  some  lines  of 
business,  such  as  newspaper  and  magazine  publishing,  for  example ; 
but  they  do  not  frequently  appear  in  the  ordinary  mercantile  business. 

Deferred  Charges.  A companion  principle  to  the  one  which  opened 
this  chapter  is  this : An  expense  or  a cost  is  incurred  in  the  period 
receiving  the  benefit  regardless  of  the  time  of  the  cash  payment.  When 
we  acquire  merchandise  in  a given  period  it  is  considered  in  that 
period’s  calculation  of  Profit  and  Loss  whether  it  has  been  paid  for 
yet  or  not ; the  same  can,  of  course,  be  said  about  expenses ; if  electric 
light  is  used,  its  value  is  recoverable  out  of  current  profits  in  spite 
of  the  fact  that  the  cash  is  not  paid  to  the  Light  Company  until 
later.  What  would  be  the  situation  if  we  had  paid  for  our  expenses 
in  advance — paid  for  a year’s  electric  current,  say? 

Clearly  we  would  have  a valuable  right  outstanding  against  the 
Light  Company  which  they  would  have  to  discharge  month  by  month 
as  we  wanted  to  use  electricity — in  a word,  we  have  here  something 
closely  akin  to  an  Asset,  though  not  one  in  truth.  AVhat  we  do  have 
is  a deferred  Charge — an  expense  paid  in  advance. 

As  in  the  case  of  Deferred  Income,  so  here,  period  by  period  the 
proper  portion  of  the  Deferred  Charge  is  transferred  to  some  Expense 
account  (and  thence  to  Profit  and  Loss),  while  the  balance  remaining 
is  carried  forward  in  the  account  (and  in  the  Balance  Sheet)  to  the 
next  period,  these  to  be  further  reduced  and  so  on  to  the  end. 


55 


One  of  the  most  commonly  met  examples  of  Deferred  Charges 
is  Supplies,  like  paper,  advertising  matter,  ink,  etc.  which  are  often 
bought  in  larger  quantities  than  the  needs  of  one  period  would  require. 
Another  common  Deferred  Charge  is  Unexpired  Insurance. 

There  are  two  ways  of  dealing  in  the  accounts  with  facts  of  this 
kind,  either  of  which  is  good  if  consistently  followed.  Take  Insurance 
as  an  example.  We  may  have  the  Insurance  Account  classed  as  an 
Expense.  In  this  case  the  balance  would  be  one  to  be  transferred  into 
the  Profit  and  Loss  Account  at  the  end  of  the  month.  Should  there 
be  any  Unexpired  Insurance  in  this  account  it  will  have  to  be  removed 
before  the  account  is  closed.  The  entries  in  their  sequence  are — 

(1) 


Insurance  $ 1,200 

Cash $ 1,200 


Insurance  premium  paid  for  year  in  advance 

(2) 

Deferred  Charges  

Insurance  

to  transfer  11/12  of  the  Insurance  Account  to 
a Deferred  Charges  Account  at  the  end  of 
the  first  month. 

(3) 

General  Administrative  Expense 

Insurance  

to  close  the  balance  of  Insurance  Account  into 
Expense. 


1,100 


100 


1,100 


100 


If  this  method  be  followed,  the  Unexpired  Insurance  will  have 
to  be  brought  back  to  the  Insurance  Account  after  the  latter  is  closed 
and  ruled  so  the  process  can  be  repeated  in  the  next  period  just  as 
merchandise  Inventory  is  restored  to  the  Purchases  Account. 

On  the  other  hand  we  may  choose  to  regard  Insurance  Account 
as  being  itself  in  the  nature  of  a Deferred  Charge  Account — i.  e.  the 
balance  shall  represent  the  amount  of  Insurance  unexpired.  In  order 
to  keep  the  account  according  to  these  designated  characteristics,  it 
is  only  necessary  to  remove  the  amount  of  expired  Insurance  at  the 
end  of  the  period  by  Journal  Entry.  The  sequence  here  is  as  follows — 


(1) 

Insurance  $ 1,200 

Cash $ 1,200 

Insurance  premium  paid  for  year  in  advance. 

(2) 

General  Administrative  Expense  100 

Insurance  100 

to  transfer  to  Expense  the  expired  portion  of 
Insurance. 


56 


As  far  as  the  Insurance  Account  is  concerned  this  ‘latter  is  the 
simpler  treatment  but  it  should  not  be  followed  for  that  reason  if  it 
is  inconsistent  with  the  treatment  accorded  other  Deferred  Charges, 
such  as  Supplies.  If  Supplies  are  treated  first  as  expenses,  (debited 
to  Expense)  and  later  adjusted  by  the  removal  of  the  unused  portion, 
the  treatment  of  Insurance  should  be  similar.  Either  that  or  Supplies 
should  be  treated  like  Insurance  in  the  second  illustration  above. 
Similar  accounts  should  receive  similar  treatment. 

Adjustments  are  made  for  Deferred  Charges  and  Deferred  In- 
come in  order  to  carry  over  prepaid  items  into  the  subsequent  period 
where  they  are  used.  There  are  adjustments  also  in  the  case  of  ser- 
vices, etc.  used  in  the  current  period  but  paid  for  in  later  periods. 

Accrued  Liabilities.  Wages,  for  example,  and  Interest,  accumu- 
late day  by  day  but  for  convenience  are  charged  to  Expense  when 
paid  rather  than  daily.  Wages  are  paid  usually  once  each  week; 
Interest  whenever  the  interest-bearing  note  is  paid.  Now  if  the  end 
of  the  month  falls  between  pay  days  or  between  payments  of  interest, 
a certain  amount  of  wages  and  interest  will  have  accumulated  unpaid 
in  the  interim.  These  accrued  wages,  etc.,  are  as  much  a part  of  the 
costs  of  the  period  just  closed  as  if  they  were  paid  in  cash,  for  the 
services  of  the  employees  has  been  rendered  within  the  current  month. 
It  will  be  noted,  too,  that  since  the  work  has  been  done,  the  employees 
are  owed  the  wages  even  though  the  money  be  held  back  until  Sat- 
urday. To  the  business,  then,  there  is  a direct  liability  not  yet  ex- 
pressed in  the  accounts. 

Before  closing  at  the  month’s  end,  an  adjustment  entry  is  to  be 
made  to  set  up  these  unrecorded  liabilities  and  to  bring  the  unrecorded 
costs  into  the  nominal  accounts  while  they  are  still  open.  The  entry 
for  accrued  wages  not  due  is  as  follow^s ; 

Expense  (or  proper  sub-expense  account)  200 

Accrued  Liabilities  $ 200 

to  set  up  wages  accrued  but  not  due  for  the 
three  days,  Aug.  29,  30,  and  31. 

Any  other  liabilities  not  recorded  on  the  books  are  brought  in  at 
this  time  in  a similar  entry  or  as  a part  of  this  one. 

Accrued  Assets.  As  one  would  surmise,  there  are  also  certain 
adjustments  to  be  made  for  accumulating  Assets  which  are  not  yet  due. 
Interest,  commission  earned  by  us,  etc.  accrue  day  by  day,  but  like 
wages,  are  not  brought  into  the  accounts  daily  because  of  the  un- 


57 


necessary  inconvenience  of  doing  so.  When  the  end  of  a period  is 
reached,  however,  such  items  must  not  be  overlooked.  Take  commis- 
sions due  us,  for  example;  it  may  be  the  agreement  that  they  shall 
be  settled  for  only  once  in  three  months.  At  the  end  of  the  first  month 
there  is  an  amount  accrued  because  the  selling  service  has  been  per- 
formed but  not  due  because  of  the  three  month  agreement.  Our  ac- 
counts cannot  express  the  whole  truth  of  the  present  situation  unless 
an  adjustment  be  made  to  increase  the  earnings  of  this  month  by  the 
amount  of  the  commissions  and  to  increase  the  Assets  by  the  amount 
to  be  paid  to  us  at  a later  date.  The  entry  would  be : 

Accrued  Assets $ 400 

Commission  Earned  $ 400 

to  bring  into  the  current  period  the  earnings 
from  commissions  not  yet  due  or  collectable. 

Other  accrued  Assets  would  be  adjusted  through  this  or  a similar 
entry. 

The  following  series  of  entries  will  show  the  sequence  of  adjust- 
ments for  one  type  of  transaction;  but  it  may  be  used  as  a guide  for 
other  types  of  adjustment  transaction  at  will.  It  will  be  well  in 
studying  this  series  if  entries  to  open  memorandum  accounts  and  post 
each  step  as  it  is  taken  so  the  slowly  effected  alteration  in  the  Ledger 
may  be  observed. 

(1)  July  12 

Selling  Expense  $ 2,000 

Cash 

20.000  advertising  circulars  purchased. 

(2)  July  31 

Deferred  Charges 1,800 

Selling  Expense  

18.000  circulars  unused  and  carried  over  to 
subsequent  periods. 

(3)  July  31 

Profit  and  Loss 200 

Selling  Expense  

to  close  the  remainder  of  Selling  Expense 
Account  to  the  current  Profit  and  Loss  Ac- 
count. 


Step  (1)  shows  the  acquisition  of  Expense  Material;  step  (2) 
the  removal  of  the  unused  portion;  step  (3)  the  removal  of  the  used 
portion ; since  the  unused  circulars  are  to  be  used  in  later  months  it 
is  not  unnatural  that  they  should  soon  be  restored  to  the  expense  ac- 
count for  the  next  month.  That  is  step  (4)  of  the  sequence. 


$ 2,000 


1,800 


200 


58 


(4) 


Aug.  1 (or  Aug.  31) 


Selling  Expense  $ 1,800 

Deferred  Charges $ 1,800 

to  restore  the  unused  circulars  to  the  Ex- 
pense Account  after  it  is  closed  for  July. 

Entry  (4)  as  far  as  it  affects  Selling  Expense,  is  identical  with 
the  record  of  a fresh  purchase  during  the  month  of  August.  Indeed, 
it  may  help  to  think  of  the  adjustment  as  showing  a purchase  of 
circulars  by  one  period  from  the  preceding  one.  Again  it  may  help 
to  think  of  these  adjustments  as  a special  form  of  Inventory  handed 
on  by  one  period  to  be  used  in  the  next. 

After  entry  (4)  the  series  would  begin  again  and  follow  the  same 
course.  A typical  Selling  Expense  Account  would  be  like  the  follow- 
ing; 


Selling  Expense 


July  12 — Circulars  purchased 

$2,000 

July  31 — Unused  circ.  de- 
ferred 

July  31 — Closing  used  circ. 

$1,800 

to  P/L  a/c 

200 

Aug.  1 — Unused  circ.  from 

Aug.  31 — Deferred  Selling 

July  _ . 

. 1,800 

Exp. 

- 1,500 

Aug.  14 — Other  selling  costs 

3,000 

$4,800 

Aug.  31 — Close  Balance  to 
P/L  a/c 

3,300 

$4,800 

Etc. 

It  is  equally  easy  to  think  of  Deferred  Income  as  a special  kind 
of  Inventory  of  Incomes  which  is  removed  temporarily  from  the  cur- 
rent period’s  income  account,  carried  in  a special  account  by  itself 
while  the  books  are  being  closed,  and  then  restored  to  the  Income 
account  for  the  month  following.  It  may  help  to  think  of  Accrued 
Assets  in  the  light  of  a special  kind  of  earning  or  sales  on  account 
later  to  be  received  in  cash ; it  may  help  to  conceive  Accrued  Liabili- 
ties as  a kind  of  purchase  or  expense  on  account  later  to  be  paid  in 
cash.  But  the  principal  guide  to  making  adjustment  entries  is  this : 
make  whatever  Debits  and  Credits  are  necessary  to  raise  or  lower  costs, 
earnings,  assets  or  liabilities  to  the  true  amount  according  to  the  best 
information  at  hand. 

Reserves.  There  is  one  other  matter  to  be  considered  while  on 
the  subject  of  adjustments  to  secure  true  costs,  and  that  is  reserves.  We 


59 


know  that  with  constant  use  our  Fixed  Assets  of  Buildings,  Machinery, 
etc.  wear  out,  and  we  know,  too,  that  it  is  quite  likely  some  of  our 
Accounts  Receivable  will  never  be  collected  in  cash.  If  it  were  merely 
a question  of  waiting  to  make  the  necessary  adjustment  until  the 
machine  was  worn  out  or  until  John  Hamilton’s  account  proved  un- 
collectable, the  explanation  would  be  short  and  easy.  We  should 
simply  eliminate  the  worthless  asset  by  decreasing  the  account  and 
charging  the  amount  against  profits. 

But  we  are  to  note  that  the  wear  and  tear  on  Buildings  and 
Machinery  from  their  being  used  goes  on  month  by  month ; that  they 
contribute  day  by  day  to  the  care  and  disposition  of  everything  we 
sell ; that  the  wearing  out  of  machines  is  as  much  a cost  as  a rent  for 
them  would  be.  And  we  are  also  to  note  that  an  uncollectable  Account 
Receivable  is  quite  as  much  a loss  and  a reduction  of  the  profits  as 
the  destruction  by  fire  of  the  original  goods  would  have  been. 

The  depreciation  of  Fixed  Assets  is  in  the  nature  of  a Selling 
Expense  if  the  particular  asset  suffering  wear  and  tear  is  used  in 
promoting  sales;  if  the  asset  cannot  be  intimately  connected  with 
selling,  the  Depreciation  is  considered  as  a General  Administrative 
Expense.  An  uncollectable  debt  may  be  brought  into  a new  account. 
Loss  on  Doubtful  Accounts,  and  through  it,  closed  into  Profit  and  Loss 
Account. 

Perhaps  the  natural  entry  to  express  Depreciation  would  be  this : 


General  Administrative  Expense  $ 100 

Machinery $ 100 


to  transfer  out  of  Machinery  Account  the 
amount  representing  the  portion  of  the  value 
of  the  machine  consumed  in  wear  and  tear 
in  the  current  period. 

It  would  seem  logical  thus  to  decrease  the  balance  of  Machinery 
Account  month  by  month  as  it  wore  out.  But  business  men  prefer 
to  keep  the  original  cost  of  the  Fixed  Assets  intact  as  a matter  of  re- 
cord. This  means  depreciation  cannot  well  be  credited  to  the  asset 
direct.  What  we  do  to  avoid  this  situation  and  still  have  the  costs 
correct  is  to  provide  a separate  account  which  shall  take  the  place  of 
the  credit  side  of  the  Asset.  The  credits  of  the  adjusting  entry  for 
depreciation  comes  to  this  Reserve  for  Depreciation  Account  just  as 
if  the  new  account  was  the  split-off  credit  side  of  the  Asset  Account.  In 
the  Balance  Sheet  the  Reserve  (credit  balance)  is  deducted  from  the 
Asset  (debit  balance)  and  the  resulting  present  value  of  the  machinery 

60 


is  as  clearly  shown  as  if  the  Machinery  Account  itself  had  received 
the  depreciation  credits. 

Perhaps  it  would  seem  logical  also  to  credit  Accounts  Receivable 
for  uncollectable  accounts.  But  let  it  be  noted  that  to  follow  that 
plan  one  would  have  to  wait  until  long  after  the  sale  of  the  goods. 
The  profits  of  that  later  period  should  not  bear  the  burden  for  the 
bad  debts  contracted  in  an  earlier  period  merely  because  the  debt  is 
just  now  ascertained  to  be  uncollectable. 

Actuated  by  the  desire  to  show  in  each  current  period  all  costs 
and  losses  reasonably  belonging  in  that  period,  we  deduct  from  cur- 
rent profits  an  amount  which  experience  tells  us  will  approximate  the 
actual  loss  from  bad  debts  later  to  be  experienced.  Instead  of  credit- 
ing the  Accounts  Receivable  Account  at  this  time,  the  amount  is 
carried  to  a Reserve  for  Uncollectable  Accounts.  We  could  not  credit 
Accounts  Receivable  for  no  one  can  tell  now  which  of  the  several  cus- 
tomers ’ accounts  will  ultimately  prove  uncollectable,  though  we  may 
be  fairly  certain  that  in  the  long  run  about,  say,  one  per  cent  of  the 
sales  will  be  lost  from  bad  debts. 

There  are,  then,  two  other  adjusting  entries  to  be  made  in  addi- 
tion to  the  ones  for  accrued  and  deferred  items  and  before  closing 
the  nominal  accounts.  The  two  new  others  are  these : 


General  Administrative  Expense $ 140 

Selling  Expense  80 

Reserve  for  Depreciation 

to  charge  depreciation  on  Fixed  Assets  into 
the  current  period’s  expenses. 

Loss  on  Bad  Debts 200 

Reserve  for  Bad  Debts 


to  establish  a reserve  of percent  of  the 

current  sales  to  cover  future  losses  in  col- 
lections. 


? 220 


2C0 


i;' 


61 


TO  THE  STUDENT 


This  outline  of  assignments  prescribes  the  sequence  in  which  the 
work  in  Accountancy  la  is  to  be  done.  It  is  arranged,  as  far  as  pos- 
sible, so  that  practice  work  involving  new  accounts,  books,  etc.  will 
not  be  taken  up  until  after  the  newer  topics  have  been  studied  at  home 
and  discussed  in  quiz  class.  A new  topic  will  usually  follow  this  order : 

(1).  Home  Study  (2).  Recitation  (3).  Practice.  It  will  be  noted 
in  the  program  of  hours  that  each  practice  class  is  preceded  by  a 
discussion  period  wherein  the  approaching  practice  work  is  to  be 
considered  and  tests  made  of  the  thoroughness  with  which  past  prac- 
tice work  and  home  study  has  been  done. 

In  a course,  such  as  Accountancy  la,  three  credit  hours  requires 
on  the  average  nine  hours  a week  work.  In  our  case  this  is  divided 


as  follows : 

Practice  work  in  Laboratory 4 hours  a week 

Recitation  class  work 2 hours  a week 

Preparation  for  recitation  (average) __  2 hours  a week 

8 hours  a week 

Unspecified  1 hour  a week 

Total  9 hours  a week 


Thus  eight  hours  of  work  is  provided;  the  extra  hour  to  make 
up  the  nine  for  this  course  may  be  regarded  as  a margin  to  be  em- 
ployed to  the  most  advantage  by  the  individual  student  in  study  or 
in  bringing  back  work  up  to  date.  The  home  assignments  can,  on 
the  average,  be  prepared  in  one  hour  for  each  recitation ; the  practice 
class  assignments  are  about  what  the  average  student  is  expected  to 
accomplish  in  the  two  hours.  If  the  work  falls  noticeably  behind  the 
program  for  any  reason,  it  should  be  made  up  outside  of  the  regular 
periods  as  soon  as  possible. 


62 


PROGRAM  OF  ASSIGNMENTS 

Accountancy  la 


QUIZ  ASSIGNMENTS 

1 —  Introduction  to  Elementary  Ac- 
counting, Chap.  I — The  Pur- 
pose of  Accounting. 

2 —  Introduction  — Chap.  II  — The 
Transaction. 

3 —  Review  first  two  chapters;  dis- 
cuss the  problems  worked  in 
practice  class. 


4 —  Introduction,  Chap.  Ill  — The 
Ledger. 

5 —  Oral  analysis  and  recitations  on 
problems  from  Chap.  Ill  and 
others  to  be  stated  by  the  in- 
structor. 

6 —  Introduction,  Chap.  IV — Trial 
Balance  and  Statements. 

7 —  (a)  Introduction,  Chap.  V — 
Personal  accounts  and  the  Jour- 
nal. , 

(b)  .20th  Century  text  pp.  30- 
33. 

8 —  (a)  Introduction,  Chap.  VI — 
Special  Books  of  Original  En- 
try. 

(b)  20th  Cent,  text,  pp.  34-42. 

9 —  Study  Jan.  transactions  in  ad- 
vance at  home  and  recite  on 
them  in  quiz  class. 

10 —  (a)  Introduction,  Chap.  VIII — 
Direct  Ledger  Closing. 

(b)  Compare  with  explanation 
and  illustration  p.  i;95-6  of  20th 
Cent.  text. 

11 —  Introduction,  problems  from 
Chap.  VII. 

12 —  One-hour  written  quiz. 

13 —  Study  Feb.  transactions  in  ad- 
vance at  home  and  recite  there- 
on in  class. 

14 —  (a)  Introduction,  Chap.  VIII 
and  problems — Journal  Closing, 
(b)  Uompare  with  explanations 
and  illustrations  p,.  07-70  of 
20th  Cent.  text. 


PRACTICE  ASSIGNMENTS 

1 — Problems  from  Chap.  1. 


2 —  Problems  1 and  2 from  Chap. 
II. 

3 —  (a)  Problem  3,  from  Chap.  II. 
(b)  Follow  instruction  for  prob- 
lem 2 Chap.  II,  using  the  data 
in  Exercise  24,  p.:  44  of  20th 
Century  text. 

4 —  Problems  from  Chap.  III. 

5 —  Follow  instructions  in  problem 
1,  of  Chap.  Ill,  but  use  the 
transactions  in  the  following 
Ex.  in  20th  Century  text — Ex. 
3-5-9-11-15-18. 

6 —  Problems  from  Chap.  IV. 

7 —  (a)  Problems  from  Chap.  V. 
(b)  Journal  Entries  for  Exer- 
cise 25,  p.  45  of  20th  Cent.  text. 


8 —  Begin  Set  I;  go  as  far  as  Jan. 
12. 

Sales  figures  will  be  given  by 
instructor. 

9 —  Continue  Set  I to  Jan.  24.  The 
instructions  to  post  on  Jan.  14 
are  to  be  omitted. 

10 — (a)  Finish  Jan.  transactions 
and  post. 

(b)  Jan.  Trial  Balance. 


11 —  Jan.  Statements  and  direct  clos- 
ing of  Set  I. 

12 —  Two-hour  problem  quiz. 

13 —  Set  I to  Feb.  24.  The  Instruc- 
tor will  advise  as  to  abbrevi- 
ating the  clerical  work  in  the 
Sales  Book. 

14 —  Finish  Feb.  entries,  posting  and 
Trial  Balance. 


63 


15 —  20th  Cent,  text  pp.  71-83  and 
92-95.  Notes  and  Interest.  How 
to  calculate  interest  and  dis- 
count, and  how  to  make  entries 
from  the  results. 

16 —  (a)  Transaction  Book,  pp.  20- 
26.  Study  and  Journalize  all 
note  transactions  in  March. 

(b)  Transaction  Book,  pp.  17. 
First  10  problems  of  Ex.  47h. 

17 —  (a)  Recite  on  interest  problems 
worked  in  practice  class. 

(b)  20th  Cent,  text,  pp.  97-125. 
Study  Set  II  accounts.  Need 
not  work  the  exercises. 

18 —  (a)  20th  Cent,  text,  pp.  126-137. 
Study  illustrations  and  explan- 
ation of  April  books;  give  spe- 
cial attention  to  the  purpose 
and  use  of  the  special  columns, 
(b)  Study  and  recite  on  part  of 
April  transactions  in  advance. 

19 —  Continue  study  and  recitation 
on  April  transactions. 

20—  20th  Cent,  text,  pp.  139-141— 
Errors  in  the  Trial  Balance  to 
be  supplemented  by  instructor. 

21 —  (a)  Introduction,  Chap.  IX — 
Periodical  Adjustments. 

(b)  20th  Cent,  text,  pp.  143-158. 

22 —  Introduction.  Problems  from 
Chap.  IX. 

23—  Review  Adjustments,  Closing 
and  Statements. 

24— ^Written  quiz. 

25 —  Study  and  recite  on  May  trans- 
actions in  advance. 

26 —  Continue  with  May  transac- 
tions— study  and  recitation. 

27—  20th  Cent,  text,  pp.  161-167— 
Consignment  accounts. 

28 —  Special  mimeograph  problem  in 
Consignments  Outward. 

29 —  Special  mimeograph  problem  in 
Consignments  Inward. 

30—  20th  Cent,  text,  pp.  172-176,  in- 
cluding Ex.  77  and-  80  to  be 
done  on  cross  ruled  paper.  Dis- 
cussion of  advantages  of  chart- 
ed figures. 

31 —  Review  of  the  course. 

32 —  Review  continued. 


15 — Feb.  Statements  and  Closing  by 
Journal  Entries.  Hand  In 
Set  I. 


16 —  (a)  20th  Cent,  text,  pp.  95-6, 
Ex.  54.  Prepare  calculation  of 
all  interest  before  making 
Journal  Entries. 

(b)  Transaction  Book,  p.  18, 
problems  19-25. 

17—  Set  II  to  April  9,  including  the 
posting. 


18 — Set  II  to  April  16. 


19—  Set  II  to  April  26,  including 
posting,  but  omitting  the  Ex- 
ercise mentioned  on  page  11. 

20—  Set  II,  finish  April  transac- 
tions, posting  and  Trial  Bal- 
ance. 

21 —  Ex.  66a.  Omit  the  first  Trial 
Balance  but  make  the  Adjust- 
ing entries,  post  and  take  sec- 
ond Trial  Balance. 

22 —  Ex.  66a.  Journal  entries  to 
close  and  statements. 

23—  Set  II,  transactions  to  May  9. 

24 —  Written  problem  quiz. 

25—  Transactions  to  May  17. 

26 —  Transactions  to  May  22. 

27 —  Transactions  to  May  29. 

28—  Final  posting  and  May  Trial 
Balance. 

29 —  May  Statements  for  Set  II. 

30 —  May  Adjustments  and  Closing. 
Hand  in  Set  II  Books. 


31 —  Reviews,  or  Prob.  68,  p.  159. 

32 —  Review  or  problem  continued. 


V 


